Has china lost its low cost edge?

Has China Lost Its Low-Cost Edge?

Laura Hodges

Director, Pricing and Purchasing Service

September 27, 2012

Copyright © 2012 IHS Inc. All Rights Reserved.

www.ihs.com/PricingPurchasing

Why the Concern about China?

• Recent studies have suggested that China has or will lose its low-cost

status over the next 3 years

• Buyers report that Chinese quality has just reached their comfort level

• Should you be concerned?

• Labor costs are exploding but remain low and productivity is high

• The renminbi will continue to appreciate over the long-term

• No cost advantage for most material prices

• Shipping costs are at extremely low levels

• How should this impact your sourcing decisions?

• Are there other countries that you should consider?

http://www.ihs.com/PricingPurchasing



3

China’s Rising Profile in US Trade

4

6

8

10

12

14

16

18

20

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

China Canada Mexico Japan

Share of U.S. Nominal Merchandise Imports, By Country, %

Source: IMF Direction of Trade Statistics.




4

China Also Plays A Larger Role In Supply Chains

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Base Metals* Steel Cement

China as a Percentage of Global Production

*consumption




North America27.1%

Other Americas

6.3%

Western Europe25.2%

Emerging Europe6.4%

Japan8.7%

Other Asia, Pacific20.5%

Mideast, Africa5.8%

2010

US 22.9%

China 9.4%

India 2.7%

The Chinese Economy Takes Over the Top Spot

2020

North America20.1%

Other Americas

7.1%Western Europe19.6%

Emerging Europe7.5%

Japan5.7%

Other Asia, Pacific33.8%

Mideast, Africa6.1%

US 16.9%

China 19.6%

India 5.5%

Share of world GDP, measured in nominal US dollars




Yet, Overall Labor Costs Are Still Very Low

• The average Chinese manufacturing worker earns approximately

$2.50 per hour

• This reflects a more than 12.5% annual growth over the past decade

• Strong upward pressures on wages

• Minimum wages are rising by more than 20% annually in some provinces

• Inflation rising with higher food and energy costs

• Productivity gains pushed 10% higher annually

• However wide disparity exists across the country and occupation

• Over the next decade, wages are expected to double and will grow

another 10-15% in the next 3-5 years




No Chinese Advantage on Material Costs

0

200

400

600

800

1,000

1,200

1,400

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US Europe China

Global Cold-Rolled Sheet Prices

(USD per metric ton)

0

2,000

4,000

6,000

8,000

10,000

12,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US Europe China

Global Copper Prices

(US$ per metric ton)

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US Europe Southeast Asia

Global Ethylene Prices


0200

400600

8001,000

1,2001,4001,600

1,8002,000

2,2002,400

2,6002,800

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US Europe Northeast Asia

Global Polypropylene Prices





Canadian Dollar Euro

Japanese Yen Chinese Renminbi

(Canadian dollars per US dollar, quarterly averages) (Euro per US dollar, quarterly averages)

(Yen per US dollar, quarterly averages) (Yuan per US dollar, quarterly averages)

Continued RMB Appreciation

8




0

2,000

4,000

6,000

8,000

10,000

12,000

2003M1 2005M1 2007M1 2009M1 2011M1

(Baltic Dry Index, 1985=1000)

Shipping Rates Are Not A Concern

Abundant supply should

keep rates low for at least

the next three years




Productivity Gains Have Been Strong

10,000

20,000

30,000

40,000

50,000

2005 2006 2007 2008 2009 2010 2011

(Chinese output per employee, USD)

Productivity has almost doubled since 2005,

reducing the true impact of higher wages




Cost ('000s) Share

Payroll 1,353,198 9.85%

Production 970,245 7.06%

Management 382,953 2.79%

Energy 1,499,672 10.92%

Material 10,881,765 79.23%

Scrap 5,651,202 41.15%

Ferrous shapes & forms 2,560,415 18.64%

Sand 512,083 3.73%

Industrial equipment 292,619 2.13%

Nonmetallic products 292,619 2.13%

Nonferrous shapes & forms 329,196 2.40%

Other 1,261,919 9.19%

Production Costs 13,734,635 100.00%

Chinese Production Costs for Steel Castings

(Source: 2010 Annual Survey of Manufacturers)

How Does this Impact China’s Cost Advantage?

Cost ('000s) Share

Payroll 5,412,793 30.42%

Production 3,880,981 21.81%

Management 1,531,812 8.61%

Energy 1,499,672 8.43%

Material 10,881,765 61.15%

Scrap 5,651,202 31.76%

Ferrous shapes & forms 2,560,415 14.39%

Sand 512,083 2.88%

Industrial equipment 292,619 1.64%

Nonmetallic products 292,619 1.64%

Nonferrous shapes & forms 329,196 1.85%

Other 1,261,919 7.09%

Production Costs 17,794,230 100.00%

Value of Shipments 27,100,175 65.66%

US Production Costs for Steel Castings

(Source: 2010 Annual Survey of Manufacturers)

Assume material costs are roughly equal

The average Chinese manufacturing worker is only 40% as productive as the same US worker

The average Chinese manufacturing wage is only 10% of the US wage

The Chinese cost advantage is 23% in 2010




100.0

110.0

120.0

130.0

140.0

150.0

160.0

170.0

2010Q1 2012Q1 2014Q1 2016Q1 2018Q1 2020Q1 2022Q1

US China

(Cost Index, Steel Castings, 2010Q1=100)

Cost Erosion Continues In the Next Decade

Existing 23% Cost

Advantage

Eliminated by End

of Decade




Cost Saving Still Exists But For How Long?

• Using this example, casting production costs in China are

approximately 23% lower than those in the US

• Shipping costs, exchange rate appreciation, and supply chain

risks do cut into these savings

• While it may still make sense to source from China, the

margins are narrowing

• Over the next decade, Chinese wages are expected to move

from 10% of US wages to 25%

• This is enough to make China uncompetitive for your basic

manufactured goods




0.00 10.00 20.00 30.00 40.00 50.00

Norw ay

Sw itzerland

AustraliaGermany

CanadaJapan

United States

UnitedKorea, South

Argentina

PortugalCzech

Taiw anSouth Africa

Brazil

HungaryMalaysia

MexicoRomania

Venezuela

TurkeyChina

Peru

IndiaThailand

PhilippinesIndonesia

Vietnam

Pakistan

Global Manufacturing Wages (USD per hour, 2012)

Lower-Cost Countries Are Also Available

Depending upon your

location, Indonesia, and

Mexico may be good

alternative sourcing options




Indonesia Offers an Attractive Option

0.00

2.00

4.00

6.00

8.00

2000 2005 2010 2015 2020

Mexico China Indonesia

(Manufacturing wage, USD per hour)




No Country is Without Risks

The Risk Scores represent a subjective probability of a range of business risks in a given

country, and the numbers range from 0 to 100, with lower numbers representing lower risk

The China risk score is currently 14 (1-Year) and 33 (5-Year)

Mexico - Exporter Risk Rating - 10 (1-Year) / 23 (5-Year)

- A cumbersome bureaucracy and endemic corruption persists

- Increased violence from drug gangs and a clampdown on organised crime

- A labour surplus exists but shortage of technically skilled workers is a problem

- Renewed efforts to make labour laws more flexible but political resistance is strong

Indonesia - Exporter Risk Rating - 11 (1-Year) / 34 (5-Year)

- Endemic corruption, inefficient bureaucracy, and red tape are a challenge

- Reform on business regulations has slowed markedly over the last few years

- A 40-hour limit on the working week is comparative disadvantage

- Indonesia's labour force is under-educated




Implications for Buyers

• China will retain its low-cost status over the next five years …

• … depending upon the labor intensity of the manufacturing process

• Labor was the primary advantage in China

• And those costs are rising along with the exchange rate

• Expect a pause this year for exchange rates but wages will grow near 10%

• But China is approaching the end of its low-cost status

• For high-labor, low-margin goods, start looking for alternative low-

cost countries (Indonesia) or ones closer to home (Mexico)

• Be aware of the unique risks in each country




Thank you!

Americas

Marc Venditti

+1 781 301-9325

Asia/Pacific

Christopher Munch-Fals

+65 6576 5354

Europe, Middle East & Africa

Natalie Rowlands

+44 203 159 3260

Contact IHS today to learn more…


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Has china lost its low cost edge?