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China Too Expensive? That Depends

By Dan Harris and Steve Dickinson

All Roads Lead to China has a very helpful post, entitled, "Is China No Longer Competitive?" All Roads asks the question and then proceeds to answer it in the only sensible way: it depends. The question is asked in the context of all the media reports of prices rising in China and companies fleeing because of it. My views on this have remained constant. China was NEVER the place for everyone and it never will be. On the flip side, it is a great place for certain companies. During the absolute height of the China craze, I asked a very well run, very prosperous fishing company client of ours why it was not sending its fish over to China for processing when it seemed like all its competitors were doing so. I was so drunk on China as the place to be at that point that I assumed the client would respond by saying something about how it was planning to go to China but it just had not yet found the right people over there to get started. Instead, I was told something along the lines of the following:

Dan, we compared the cost of processing our fish in Alaska with doing it in China and after accounting for all costs, including shipping, and figuring a 3% decline in quality, we concluded that processing in China would save us 5 cents per pound. We then determined that savings was not enough to account for the greater risks and variabilities and so we are going to keep processing here, with the same good people we have always used, unless and until the price differential increases.

My response: "that makes complete sense." In other words, here is a company that fully analyzed the situation and very rationally decided China did not make sense for them. Deciding on whether to go to China should always be made on a case by case basis. All Roads breaks out some of the key factors for determining if China makes sense. 1) What is your China platform? Those who export Chinese products will be more exposed "to RMB changes, RMB conversion regulation, China domestic raw material increases, and the price of oil." Those who sell product into China will be more exposed to risks of policy interference and the price of transportation, but will benefit from a rising RMB. Those who manufacture in China for Chinese consumption will be the most insulated against the risks of rising transportation costs and the RMB. 2) Where is your market? Procuring raw materials in China, paying staff in RMB and billing locally removes most of the RMB risk. 3) Where are your competitors? If all your competitors are in China also, all your competitors are facing the same price increases as you and all ought to be able to raise their prices. 4) Where are your suppliers? Importers are benefiting from the rising RMB. 5) Is your product high tech or high labor?All Roads rightly notes that the bulk of the news about firms leaving China relates to low tech/high labor companies. Firms like Intel, Dell, and Nokia, all of whom have a low percentage of costs attributable to labor and transportation, the rising prices in China have not been a big factor. I know this is hard to believe (I too find it hard to believe), but I am not aware of a single client of my firm's having left China because of rising costs. This, coupled with anecdotal evidence I have heard from others and what I have read, has led me to conclude that hardly any American or European companies in China in anything but very low end products have left China. How can this be? I think the answer is that they were smart enough not to go into China to save pennies, but to save dollars and so there is enough of a savings cushion to warrant them staying. I also think this is because companies that retain foreign law firms tend to follow the law and therefore, as Rich points out below, rising costs due to increased legal enforcement in China have not really impacted them all that much, if at all. Lastly, many of these companies went into China as much to sell into China as to manufacture there and so while their costs are rising, their revenues are as well. 6) Were you previously compliant? All Roads states that those companies that were in compliance with China's laws BEFORE China started tightening up on them have not really had to change much. "This is a question that can be applied to many different areas, [including] the environment and material quality." I cannot stress enough how true this is and (for the very first time since we started this blog) I cannot resist saying, "I told you so". I am saying I told you so because we have been pounding home the need for foreign companies to be above legal reproach ever since we first started this blog. Just by way of example, here is a quote from a February, 2006, post:

We are aware of a large Fortune 500 retail company that is opening units in China that meet or exceed the toughest United States environmental laws. I estimate this company's environmental sensitivity will cost them at least an additional $25,000 per unit, yet I am firmly convinced this company is doing the right thing. This company's actions make sense because the odds are good that China's environmental laws and enforcement will get tougher over time, and building environmentally sound units now will almost certainly cost less than having to retrofit existing units a few years from now. On top of this, people often get very emotional about the environment and I can see Chinese citizens getting very angry at a foreign company whose units in China are less environmentally sound than their units in the United States or elsewhere. This is obviously even more likely to be the case if there were to be some sort of environmental disaster.

Just a few weeks ago, I spoke with someone at this Fortune 500 company about China's tightening environmental laws and she told me that her company has no problems complying and that it actually welcomes the increased scrutiny being put on their competitors. Without my even asking, she added that the same is true with respect to labor law enforcement. Is China too expensive? That depends.

Full post as published by China Law Blog on August 22, 2008 (boomark / email).