QUOTE
A new survey finds rising worries about product quality and intellectual-property theft. More U.S. companies are looking to Mexico and their own backyard
By Pete Engardio
Two years of disastrous quality-control breakdowns, from foul fish and lead-tainted toys to poisoned drugs and dairy products, are taking their toll on China's allure as a manufacturing platform. A new study by supply-chain consulting firm AMR Research found that quality concerns are among the chief reasons U.S. manufacturers are scaling back plans to source more goods from China.
Instead, U.S. companies are looking harder at Mexico and other locales closer to home when exploring where to put new capacity. The findings are based on a survey of 130 U.S. manufacturers, ranging from producers of drugs (BusinessWeek, 9/4/08) and computers to auto parts. The survey, completed in mid-October, found a sharp swing in attitudes toward China since May, when AMR conducted a similar study.
The reasons for the shift suggest serious problems for China's export machine that go far beyond the concerns over rising costs for wages, shipping, and materials that got a lot of attention earlier this year.
AMR asked U.S. manufacturers to rate different regions around the world (China and the U.S. were each counted as region unto themselves) on 15 different risks tied to sourcing products for sale in America. Just a few months ago the biggest concerns over China were rising factory wages and the hike in trans-Pacific shipping costs owing to soaring fuel prices. Since then, the 60% plunge in oil prices and a sharp falloff in U.S. imports from China have caused spot freight prices on ocean shipping to crash.
China Is Tops in Manufacturing Risk
Now, the biggest concerns over China are quality and theft of intellectual property (BusinessWeek.com, 4/27/06). Half of respondents to the survey cited China as the biggest source of "risk" for product quality failure. Fifty-seven percent rated China as the biggest risk of intellectual-property infringement. Both categories represented sharp increases from May. No other region was named as the biggest source of risk in those two areas by more than 7% of respondents.
"China is in a league of its own in terms of risks associated with intellectual property and quality," says Kevin O'Marah, AMR's chief strategist.
In fact, China ranked highest in 9 of the 15 risk factors. Rising labor costs are still an important factor for businesses, with 35% citing China as the leading source of concern. Other risk categories where China ranked highest included regulatory compliance, commodity price volatility, supply-chain security breaches, and information technology problems. The shortage of Chinese managerial talent—long one of the top risk factors during the go-go era that ended last year—has tailed off as a major worry.
The findings don't suggest a mass pullout from China, O'Marah says. Two out of three companies said they still plan to expand there, mainly because they already have operations and component suppliers in the mainland. But that's a big falloff since May, when four out of five companies said they had China expansion plans. The number of companies saying they plan to actually decrease sourcing from China rose from 9% to 17%. Asia in general is falling from favor as an import source, the AMR study found.
Less-Visible Costs of Outsourcing to China
Where are the hottest new places for manufacturing investment? For U.S. companies, Latin America seems poised to be the big winner. The number of companies planning Latin expansions rose from four out of five in May to five out of six in October. Mexico is by far seen as the leading destination, cited by 73% as the primary source for new outsourcing. AMR also found that more production work is expected to shift to the U.S., with the percentage of companies planning to invest at home rising from 22% to 33%. Of course, this snapshot of corporate plans may have changed since the survey was taken. The deepening U.S. recession may prompt U.S. companies to curtail expansion anywhere.
The souring attitude should be disturbing to China's leadership. If the issue were just eroding price advantages, that would be less cause for alarm. Costs could swing back in China's favor, for example, with fluctuations in currency rates, commodity prices, or changes in China's job market. What's more, Chinese manufacturers have a long history of sacrificing profit margins with lowball pricing to win market share.
The AMR study suggests, however, that U.S. companies are starting to better appreciate the less-visible costs of producing in China. Quality problems, rampant piracy (BusinessWeek, 10/2/08), allegations of sweatshop abuses, worker protests, and other factors not only drive up costs but also harm the value of brands and corporate reputations. "Companies are realizing that the fully loaded costs of importing from China are a lot higher than they imagined," says O'Marah.
Trouble is, China will not be able to improve its quality problem overnight. It will require a long-term transformation of China's regulatory bureaucracy, legal system, and management practices. And Beijing has been promising to control intellectual-property theft for decades, with unimpressive results. If China doesn't start making progress fast, the current slump in export manufacturing (BusinessWeek, 3/27/08) could be the beginning of a longer-term pullback.
By Pete Engardio
Two years of disastrous quality-control breakdowns, from foul fish and lead-tainted toys to poisoned drugs and dairy products, are taking their toll on China's allure as a manufacturing platform. A new study by supply-chain consulting firm AMR Research found that quality concerns are among the chief reasons U.S. manufacturers are scaling back plans to source more goods from China.
Instead, U.S. companies are looking harder at Mexico and other locales closer to home when exploring where to put new capacity. The findings are based on a survey of 130 U.S. manufacturers, ranging from producers of drugs (BusinessWeek, 9/4/08) and computers to auto parts. The survey, completed in mid-October, found a sharp swing in attitudes toward China since May, when AMR conducted a similar study.
The reasons for the shift suggest serious problems for China's export machine that go far beyond the concerns over rising costs for wages, shipping, and materials that got a lot of attention earlier this year.
AMR asked U.S. manufacturers to rate different regions around the world (China and the U.S. were each counted as region unto themselves) on 15 different risks tied to sourcing products for sale in America. Just a few months ago the biggest concerns over China were rising factory wages and the hike in trans-Pacific shipping costs owing to soaring fuel prices. Since then, the 60% plunge in oil prices and a sharp falloff in U.S. imports from China have caused spot freight prices on ocean shipping to crash.
China Is Tops in Manufacturing Risk
Now, the biggest concerns over China are quality and theft of intellectual property (BusinessWeek.com, 4/27/06). Half of respondents to the survey cited China as the biggest source of "risk" for product quality failure. Fifty-seven percent rated China as the biggest risk of intellectual-property infringement. Both categories represented sharp increases from May. No other region was named as the biggest source of risk in those two areas by more than 7% of respondents.
"China is in a league of its own in terms of risks associated with intellectual property and quality," says Kevin O'Marah, AMR's chief strategist.
In fact, China ranked highest in 9 of the 15 risk factors. Rising labor costs are still an important factor for businesses, with 35% citing China as the leading source of concern. Other risk categories where China ranked highest included regulatory compliance, commodity price volatility, supply-chain security breaches, and information technology problems. The shortage of Chinese managerial talent—long one of the top risk factors during the go-go era that ended last year—has tailed off as a major worry.
The findings don't suggest a mass pullout from China, O'Marah says. Two out of three companies said they still plan to expand there, mainly because they already have operations and component suppliers in the mainland. But that's a big falloff since May, when four out of five companies said they had China expansion plans. The number of companies saying they plan to actually decrease sourcing from China rose from 9% to 17%. Asia in general is falling from favor as an import source, the AMR study found.
Less-Visible Costs of Outsourcing to China
Where are the hottest new places for manufacturing investment? For U.S. companies, Latin America seems poised to be the big winner. The number of companies planning Latin expansions rose from four out of five in May to five out of six in October. Mexico is by far seen as the leading destination, cited by 73% as the primary source for new outsourcing. AMR also found that more production work is expected to shift to the U.S., with the percentage of companies planning to invest at home rising from 22% to 33%. Of course, this snapshot of corporate plans may have changed since the survey was taken. The deepening U.S. recession may prompt U.S. companies to curtail expansion anywhere.
The souring attitude should be disturbing to China's leadership. If the issue were just eroding price advantages, that would be less cause for alarm. Costs could swing back in China's favor, for example, with fluctuations in currency rates, commodity prices, or changes in China's job market. What's more, Chinese manufacturers have a long history of sacrificing profit margins with lowball pricing to win market share.
The AMR study suggests, however, that U.S. companies are starting to better appreciate the less-visible costs of producing in China. Quality problems, rampant piracy (BusinessWeek, 10/2/08), allegations of sweatshop abuses, worker protests, and other factors not only drive up costs but also harm the value of brands and corporate reputations. "Companies are realizing that the fully loaded costs of importing from China are a lot higher than they imagined," says O'Marah.
Trouble is, China will not be able to improve its quality problem overnight. It will require a long-term transformation of China's regulatory bureaucracy, legal system, and management practices. And Beijing has been promising to control intellectual-property theft for decades, with unimpressive results. If China doesn't start making progress fast, the current slump in export manufacturing (BusinessWeek, 3/27/08) could be the beginning of a longer-term pullback.