Will China call the tune in your industry?
By Peter Marsh
Published: June 25 2004 5:00 | Last Updated: June 25 2004 5:00
At Yamaha's sprawling grand piano factory in the Japanese town of Hamamatsu, the mood is serene. While robots carry out most of the routine operations, the 350 workers are left with the many specialist, craft-based jobs involved in building delicate, costly products that come in 700 variants.
In the past decade Yamaha - the world's biggest maker of musical instruments - has shifted many Japanese jobs to low-wage countries, including China. But the near future looks relatively secure for this plant, where Yamaha makes 80 per cent of its annual output of 22,000 grand pianos.
"It takes a lot of skill to make a grand piano, which is why it continues to be viable to base most of our production in Japan," says Shuji Ito, Yamaha president.
Arcane as it may seem, Yamaha's grand piano factory offers a neat illustration of the complex trends at work in modern manufacturing, many of which have been strongly influenced by China's growth into an industrial powerhouse.
While China is now responsible for an estimated 7 per cent of world factory output, Jonathan Woetzel, a director at the Shanghai office of McKinsey, thinks it "credible" that within two decades it will account for 25 per cent, as it reaps the benefits of low wages and soaring demand for industrial and consumer goods from its 1.3bn population.
Fear has grown in the high-cost economies that as more production migrates to low-cost nations, including China, manufacturing in the industrialised nations will shrink and huge numbers of jobs will be lost. But the repercussions for the rest of the world from China's industrial revolution are much more subtle.
China benefits in particular from vast reserves of labour, and so is unlikely to see widespread wage inflation for the foreseeable future. It will therefore have a huge impact on the world's manufacturers, mainly by providing vital parts and finished goods that can be made there more cheaply.
But China's cost advantages do not trump all factors. In certain manufacturing businesses, considerations such as factory processes, transport logistics and the market strength of particular companies will ensure that large segments of production remain in high-wage countries.
In practice, then, China will force its way into the strategies of virtually all production companies, and they will need to consider how it can help to cut costs in different parts of their global supply chain. For some industries, that will mean the wholesale shift of manufacturing and assembly operations to China. In others, most key processes will stay embedded in high-cost countries, while in a third category - likely to be the majority - the supply chain will span high and low-cost countries.
Undoubtedly, the shifts for certain industries will be profound. "For many categories of industrial and consumer goods, the country with the lowest labour costs will win out, full stop," says Jim Hemerling, a director of the China operations of Boston Consulting Group. That explains, he says, why manufacturers are basing more of their operations in China, or at least buying more components there for assembly elsewhere.
Jim Womack, president of the US-based Lean Enterprise Institute, has a different perspective. He says a shift to China makes sense for industries such as consumer electronics and clothing, where standardised processes are the norm and low factory costs paramount. But this is only part of the story.
"At the other extreme are products where the company has an airtight proprietary [technological] lead, in which case it can base its production anywhere it wants. In between these extremes is a wide range of production operations which require a lot of changes [in the process] due to the need to respond to customers' requirements and where, if the goods are for sale in western Europe or the US, China is too far away.
"There are thousands of companies in this position, many employing only a few hundred people, and in the debate about 'offshoring' manufacturing to China, they are often forgotten."
The grand pianos coming out of Yamaha's Japanese factory illustrate one end of this spectrum. Making them requires knowhow and skills built up over decades to create bulky and sophisticated items. Crucially, labour is a relatively small percentage of the total manufacturing cost. Any benefits of moving this kind of production to China, even though it may provide some components, would be outweighed by the disadvantages.
In analysing how companies should respond to the idea of moving production, or parts of production, to China, the Financial Times has devised a methodology for assessing which factors are most important. While fuller details are explained below, three concepts are particularly important: proprietary knowledge, supply "tightness" and customer responsiveness.
Proprietary knowledge can afford a technological lead that offers a shield against competitors even if operating costs remain high. Take Cirteq, based in Yorkshire, England, and a world leader in small circular clips for retaining parts in rotating machines. Cirteq makes 750m of these clips a year, 80 per cent of which it exports to countries including China.
"We feel we are ahead of Chinese competitors on account of our 50 years of experience and the highly specialised nature of what we do," says Simon Ellison, export director.
Another important concept concerns the "tightness" of a supply chain. If by going to China a business can get closer to both key suppliers and customers, this would represent a compelling reason for moving.
These criteria have been critical in the consumer electronics and telecommunications equipment industries. As large companies such as Nokia, Motorola, Siemens and Matsushita have put more of their assembly operations in China, they have influenced similar moves by hundreds of smaller suppliers.
Kevin Magenis, chief executive of Cornice, a US maker of information storage drives for the electronics industry that manufactures in southern China, says that by locating there it is close to large customers and also can buy most of the parts it needs from local factories. "It just would not be practicable to make our products in the US," he says.
But the supply tightness argument can work the other way, compelling companies to stay in high-wage countries. That is likely when a company makes finished products rather than components. Often, these products have to be tailored to the needs of individual end users - which is where the need for customer responsiveness comes in.
Lantech is a US leader in automated machines for putting goods on pallets and wrapping them with plastic. It has sales of $100m (£55m) a year, mainly in the US. Pat Lancaster, chairman, says it would be impossible to shift manufacturing from Kentucky, where it employs 320 people. "We build each of our machines individually, in a process that can take as little as 14 hours. When you have the kind of consultative process with the customer that we have, it is imperative to site the manufacturing close to them."
Paris-based Essilor, the world's biggest maker of spectacle lenses, employs a slightly different approach. It makes 180m of these lenses a year, offering 50m variants. Unlike Lantech, Essilor runs a "twin-track" strategy, operating large plants in countries such as the Philippines, Thailand and China that turn out lens "blanks". These are then adapted to the users' requirements in a network of 173 centres mainly in Europe and the US, each employing up to 300 people.
Strix, based in the Isle of Man, off the west coast of Britain, has spun this way of operating on its head. It is the world's biggest maker of electrical controls for kettles, most of which are manufactured in China.
Strix makes the majority of its controls in a plant in China, close to most of its customers. But it bases production of its patented tri- metallic strips - the vital component for the controls - in the Isle of Man. "This is a secret process, and we would never transfer the technology outside the Isle of Man for fear of outsiders learning about it," says Eddie Davies, chief executive.
Three lessons stand out for manufacturers considering what part China could play in their strategies.
First, consider the disadvantages of operating in China, as well as the benefits. Even with China's low factory-operating costs, running plants in the country is by no means easy, as earlier articles in this series concerning skills shortages and problems with joint ventures have pointed out.
Second, companies can use a range of strategies - many of them linked to deciding which parts of their own supply chains could benefit from a move into China.
Third, companies that have the most to gain from China are the ones which - throughout their operations - stress the need for innovation in both product and process design.
Kern-Liebers, a German engineering company, makes specialised metal parts - in 50,000 varieties - for a range of industries. Hans-Jochem Steim, chief executive, reckons that in the past 10 years the company has benefited from low-wage countries such as China, while pushing up employment in Germany, through a continual policy of product development.
"We aim every year to get 15-25 per cent of our sales from products that are new in the past two years. As products get older, we move them from Germany to our operations in countries such as China, which keeps them in the group [catalogue] longer and builds up sales, while adding new high-tech products on the high-wage side of the business."
Those companies that stress the importance of making products which few others can match - and regularly anticipate customers' problems before the customer does - are likely to be the ones best placed to benefit from China's industrial revolution.
TO RELOCATE OR NOT: WORK OUT WHAT YOUR COMPANY COULD GAIN BY GOING TO CHINA One way of analysing whether it makes sense to manufacture in a high-cost country is to follow a system worked out by the Financial Times for assessing the relevant factors. The FT has analysed 50 types of goods - from heart implants to shoes - to illustrate how the factors interrelate. Selected results are summarised in the table. Three broad sets of issues need to be addressed. These concern the market position of the manufacturer, the supply chain and manufacturing processes. Broadly speaking, companies with a strong market position which involves a high degree of intellectual property will have less to gain from a move to a low-cost country such as China. And those whose suppliers are not mainly in China and show few signs of moving there will have little to gain from relocating. Conversely, a business that requires low-skilled, cheap labour and whose products need few modifications to cope with the demands of individual customers in high-cost countries will see more obvious benefits than one that employs highly skilled people on processes that demand significant customisation. To create a scoring system covering these issues, the FT has identified 10 factors. Three concern market position: proprietary knowledge; product competition; and market potential for the product in China. Four are linked to the supply chain: closeness to suppliers; closeness to customers; whether the products and small and light; and whether they are easily broken (these last two factors influencing transportation). Three relate to production processes: skills needed by manufacturing employees; complexity of machines; and how much processes need to be varied to meet the requirements of customers some distance from China. While the three most important factors are, arguably, proprietary knowledge, supply "tightness" (linked to the distances involved in the supply chain) and customer responsiveness, the FT analysis accords each factor equal weight with a maximum score of 10 for each. In the chart, the closer a product's score is to 100, the stronger is the case for a move to a low-cost manufacturing base. Full details of how the calculations are worked out are given on FT.com, but the main findings are straightforward. For a product scoring above 60, it is likely that a large part of its manufacturing should move, if it has not done so already. Products in this category include shoes and clothing (the two highest scorers in the analysis), mobile phones, basic metal castings and bulk chemicals. Products scoring below 40 - including heart implants and and advanced semiconductors - will for the moment probably continue to be made mainly in the high-cost countries. Products in the 40-60 range form an intermediate group where the decisions on moving are more difficult. Products with a higher score in this range - such as door locks - already see much of their manufacturing in low-cost countries, while products with a lower score (such as sheet-metal casings) may remain in high-cost countries, for reasons such as the need to be close to customers. For the full methodology, go to www.ft.com/chinatable Do you agree with the FT scoring system? Write to peter.marsh@ft.com
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