|Return to Gunpowder|
|This Issue—Volume 5, 2007|
Amongst the overwhelming flood of “China’s
products are not safe” headlines there have been a number of articles
of late about the rising cost of
Just this week, floor products and power tool maker TTI, Techtronic Industries, the Hong Kong-based owner of such great western brands as Hoover, announced they have re-focused their expansion plans on Mexico and Eastern Europe, sighting a combination of rising raw material costs, wage inflation and increased tax burdens in China. TTI said it was sensible to shift their new investments toward production closer to their core markets as China’s competitive advantage became less significant.
How do TTI’s arguments stack up? Raw material costs have been rising everywhere so China is not alone in that. The problem with China is it’s a distorted market—distorted by centralized control which has the effect of pushing domestic prices out of sync with the rest of the world by the use of rebates and subsidies on imports and exports. From our own project work, we have seen recent cases of Ferro Chrome, Steel and Aluminium to name but three products where domestic China prices are below world prices. By the same token there are other commodities which are higher and China continues to suck in imports in large volumes. We will give TTI the benefit of the doubt then on raw materials.
How about wage inflation? It is true to say China is suffering with the Asian disease—rapid growth fuelling demand for qualified engineers and managers from a talent pool that is not able to deliver. China is not unique here. Thailand, Malaysia, India all suffer from an acute shortage of qualified engineers, accountants, doctors, and lawyers (perhaps we could all deal without the last ;-). In fact, every profession faces a shortfall as the education system has failed to keep up with demand in terms of numbers and in terms of skills, particularly for working in foreign owned companies where middle and higher staff members require good linguistic and communication skills. A recent McKinsey study estimated China will need 75,000 business leaders over the next 10 yrs versus the current stock, which is estimated at 3–5,000. Of more importance to a company like TTI it was estimated that the available pool of engineering talent in China was comparable to that of Britain, which now has a mostly service economy. What’s the problem, you ask? The universities are turning out engineers but without language skills and deep in theory with no practical skill. This scarcity of skills able to operate in foreign owned companies is driving up wage rates and pushing skill shortages to the top of most companies list of woes according to an EU Corporate Network Survey this year. This then would support TTI’s decision.
So how complex is the tax system in China? Well the system is complicated by having both tax and reporting requirements (licenses, permits, approvals etc,) at the city, state and federal (province) level. In addition there are 13 types of Chinese taxes applicable to foreign investors and their establishments in China. Customs Duty, Value-Added Tax (VAT), Consumption Tax (CT), Business Tax (BT), Foreign Enterprise Income Tax, Individual Income Tax, Deed Tax, Land Appreciation Tax, Resources Tax, Slaughter Tax, Stamp Duty, Urban Real Estate Tax and Vehicles and Vessels Usage License Tax. Not all of them are applicable to all business and it’s true to say I have not seen a tax system anywhere in the world that can be said to be simple. But clearly manufacturing in China does require a large investment in legal, accountancy and management time for foreign companies.
So is this the beginning of the end for China as the world’s manufacturing base of choice in general? No, probably not. But it could be the end of the beginning for some organizations which will soon base new investment decisions on a range of issues—not just labour rates or ex factory piece part prices. As the financial advantage of manufacturing in China reduces other factors like proximity to market, managerial control and stability, other regions will certainly benefit. And not just other low cost supply markets like Eastern Europe and Mexico, but even suppliers in the USA and Western Europe that have narrowed the gap by productivity, gained from automation and lean manufacturing. ●
is Managing Director of Aptium
Global where he leads the firm's practice
Based in Chicago, Dan Welch is Chief Mechanical Officer for a rail division of a Fortune 10 corporation. Dan oversees all sourcing activities. He has over 15 years experience in sourcing in the rail industry, working previously for industrial heavy-weights such as GE, and Union Tank Car. We caught up with Dan to get his perspective on what it takes to manage duopoly/oligopoly supply-bases. Perhaps more important, Dan offered a few suggestions for all sourcing managers.
Please give our readers some background as to
why the rail industry has so many oligopoly supply bases, and how this
may differ from other industrial supply bases.
While some of the regulations limit the number of suppliers simply due to the fact that they create difficult and very specialized hurdles to clear for design and testing, others specifically require that only approved products/suppliers be used. For many of these, the design, production and quality control processes, and even each individual production facility must be approved on a regular basis. This means that a casting that may appear to be rather simple might have 5–10 years of product development, service trials, and approval submission prior to its approval for interchange use. If you then consider the fact that product demand for rail equipment is very volatile (orders can go from 15,000 cars per year to 75,000 in a matter of 1–2 years), it is not surprising that we have seen continual consolidation of the supply base.
Not surprisingly, there are rarely more than 2–3 suppliers for a given part, and at several times during my career, there have been many occasions when the entire rail community must rely on a single approved supplier for a component that is required on every car on the continent. The material side is slightly better, but even there, only a very few steel mills can produce some of the material required to build rail cars.
So it sounds like this is a “true”
duopoly/oligopoly situation, as opposed to a self-imposed one?
Can you give an example of how having a ‘true’ oligopoly
supply base can affect the negotiation power a buyer may or may not
have with his suppliers?
Over the last several years in the sourcing world, there have been
many new technologies and processes that have been introduced (e-auctions,
eProcurement systems, etc.) In a duopoly/oligopoly, how effective have
What are some best-practices you would recommend
to buyers that have to deal with a true duopoly/oligopoly supply base?
Then you can decide what you can “offer” them. Flexibility is a key here. Can you find a way internally to “mirror” the suppliers’ capabilities and strengths? This may mean changing the way you handle payables and invoicing. Demonstrating greater flexibility in your specification requirements for alternate sub-components and helping the supplier achieve better efficiencies and economies of scale in their production process is also key. It is more attractive to the supplier to make a product that is more “mainstream”. Can you offer volume? If not, can you offer a steady, consistent stream of business? Do you pay on time, or in a shorter term than your competition? Can you sit on inventory to better fit into the supplier’s manufacturing capacity/availability? In summary, you want to differentiate yourself positively and eliminate the things that differentiate you negatively.
It is important to identify the categories that will put you in a duopoly situation early on. You want to plan well in advance, and have a long-term strategy. Ideally, you want to have long-term agreements with the suppliers that you set in place off-cycle. In other words, if your business is seasonal or cyclical, try to negotiate at the low-point of that cycle when the demand is low, with a long enough contract length to protect your business for the next high-point in the cycle.
All of these ideas can help to achieve ‘wins’ for your company. They may not always be based on better pricing (although that is possible), but they can produce ‘wins’ in areas such as delivery lead-times and quality.
Any last words of advice, for those buyers that
find themselves having to manage a true Duopoly/Oligopoly supply base?
is Director of Aptium
Global where he leads multiple engagements
This newsletter is published by Aptium
Global Inc a direct material advisory firm based in Chicago, IL.
With offices in the UK, China, India and a network of global associates,
Aptium Global works with small and medium sized manufacturing companies
to save money on direct material purchases. Smaller companies face the
same cost pressures as the Fortune 500, yet often lack budgets for cost
reduction services. Aptium Global works with organizations on a pay-as-you-save™
basis, minimizing impact on cash flow and maximizing impact on the bottom
line. We aim to publish this newsletter on a monthly basis but reserve
the right to miss a few deadlines here and there.