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Global Manufacturing – The China Challenge

In today’s global environment whoever manufactures products better, cheaper and faster, wins. Every country in the world is competing. In consumer products, China is grabbing a lot of the prizes. And they’re moving strongly into high-tech. IBM's PC business is now Chinese. Will some of the automation majors become Chinese also?

Global horizons

There is something very basic about manufacturing – value is added by taking raw materials and labor, and producing products that can be sold in high quantities, with quality, to generate good return on the investment.

In the past decade, manufacturing technology has expanded rapidly on a global scale. Many countries have mastered the methods, the quality processes, the execution systems and software. In this new century, the global spread of manufacturing knowledge is having far-reaching consequences. We are seeing fundamental changes in international business structures and deployment of global capital.

The manufacturing sector remains significant in leading economies worldwide, but faces major issues such as cost competitiveness, product innovation and how to compete in an increasingly global market. One of the very first questions is: Where in the world should the manufacturing plant be located?

Of course, innovative design and product development are important to generate competitive advantage. But design and development can be done in locations that are not necessarily tied to the production plant. Intel, for example, builds semiconductor fabrication plants in many different worldwide locations. Likewise, many automation companies build products wherever it suits their business needs.

Choice of plant location

Labor skills and availability are important, but automation (available globally) reduces dependency on those factors. This brings the choice down to proximity to material sources, and/or proximity to markets, plus lowest cost with the best quality.

During the past decade or so, it seems clear that manufacturing is tending to migrate away from the U.S. for a variety of factors, not the least being that manufacturing appears to have a negative image. PLC inventor, technology guru and author Dick Morley suggests that the idea that manufacturing is somehow bad has caused jobs to be driven out. He suggests that no community in North America really wants a new assembly plant, a printed board facility or a semiconductor enterprise. In television dramas the villain is the businessman, and the hero is the scrubby squatter who fights to prevent progress.

In the U.S. today, big factories are despised and penalized with high taxes, strict zoning regulations and infinite bureaucracy. NIMBY (Not In My Backyard) attitudes are driving manufacturing offshore. On the other hand, Ireland, China, Korea, Hong Kong and many other countries seem to be inviting industry with open arms and deferred taxes. And manufacturing people are often honored as heroes.

US manufacturing statistics

Manufacturing's share of the US economy, as measured by real GDP, has been stable since the 1940s. During this entire time, the ratio of manufacturing output to GDP has ranged from 16 to 19%. As of 2002, it was 16%.

During this same 50-year time span, with alternating booms and recessions, the number of manufacturing employees has remained fairly constant, oscillating at around 16.5 million. In the recent downturn, manufacturing employment fell to about 14.2 million.

Manufacturing has sustained its share of a growing economy with the same number of workers, mainly due to automation, which caused faster productivity growth. As the economy has grown, manufacturing's share of non-farm employment has decreased from 32% in 1947 to 11.5 % in 2002.

Automation and outsourcing are modern facts of life. So the well-intended but job-inhibiting laws that enforce things such as workers' comp, higher benefits and "living wages" simply are disincentives for employers to create jobs.

Traditional manufacturing payroll jobs simply won't be coming back. Many U.S. manufacturers, including major automation manufacturers – like GE, Emerson, Honeywell, and Rockwell – are moving production plants to other global locations like China. And this is not simply because of cheaper labor.

China Manufacturing

Let’s look at some facts about manufacturing in China today.

Continually increasing manufacturing prowess
Significant cost advantages (beyond just labor cost)
Good, repetitive quality
Worldwide market-share – 50% of cameras, 30% of air conditioners and televisions, 25% of washing machines, 20% of refrigerators
One private Chinese company makes 40% of all microwave ovens sold in Europe
The city of Wenzhou, Eastern China produces 70% of the world's metal cigarette lighters
Wal-mart – Buys $18 billion from China, providing a direct link to the US consumer

A massive shift in economic power is under way. A tenfold surge in high-quality Chinese imports at below US manufacturing costs is changing the landscape. In the US, the message is loud and clear – cut your price at least 30% or lose your customers.

There has been fierce competition in the past, but the new Chinese competition is dramatically different; they are about half the price. This has been a big factor in the loss of about 2.7 million manufacturing jobs since 2000.

Meanwhile, America's trade deficit with China keeps soaring to new records. It's likely to be more than $150 billion in 2004, and about 12% of that through the world's biggest retailer: Wal-Mart. All the other large retailers (Target, Home Dept, Sears, K-Mart) are following suit.

A new book, "The Chinese Century" has a clear message: If you still make anything labor intensive, get out now rather than bleed to death. Shaving 5% here and there won't work. You need an entirely new business model to compete.

America has survived import waves before, and it has lived with China for decades. But now something very different is happening. The assumption has always been that the U.S. and other industrialized nations will keep leading in knowledge-intensive industries while developing nations focus on lower skills and lower labor costs. That's now changed. What is stunning about China is that, for the first time, a huge country competes both with very low wages and high tech. Combine the two, and America has a problem.

How much of a problem? On one side, the benefits of the relationship with China are enormous. After years of struggling to crack the Chinese market, US multinationals like General Motors, Procter & Gamble and Motorola are finally reaping rich profits. They're making cell phones, shampoo, autos, and PCs in China and selling them to the Chinese middle class – about 100 million people, a group that should more than double in size by 2010.

Also, by outsourcing components and hardware from China, US companies have sharply boosted profits and return on capital. China's surging demand for raw materials and commodities has driven prices up worldwide, creating a windfall for US steelmakers, miners, and lumber companies. The cheap cost of Chinese goods has kept inflation low in the US and fueled a consumer boom that helped America weather a recession.

The cost of the China syndrome

But there's a huge cost to the China relationship. First there is the huge US trade deficit; China is the largest and fastest-growing part. While US consumers binge on Chinese-made goods, the US deficit is a record 6% of GDP. The trade shortfall – coupled with the US budget deficit – is driving the dollar ever downward, raising fears that cracks will appear in the global financial system. By keeping its currency pegged to the $ at an undervalued level, China amplifies the problem.

In the meantime, America's industrial base has eroded to a dangerous level, not only in the old segments, but in more advanced tech-industries. China is adding state-of-the-art capacity in cars, specialty steel, petrochemicals, and microchips. These plants are aimed at meeting seemingly insatiable demand in China. But if China's growth stalls, the resulting glut will turn into another export wave and disrupt American industry.

Meanwhile, U.S. companies are no longer investing in much new capacity and the ranks of U.S. engineers are thinning. By contrast, the number of Chinese engineers is growing by 350,000 annually, young workers and managers willing to put in 12-hour days and work weekends, an unparalleled component and material base in electronics and light industry, and an entrepreneurial zeal to do whatever it takes to please big retailers such as Wal-Mart.

And Chinese producers are hardly standing still. In a recent survey of Chinese and U.S. manufacturers by Industry Week, 54% of Chinese companies cited innovation as one of their top objectives, while only 26% of U.S. respondents did. Chinese companies spend more on worker training and enterprise-management software. And 91% of U.S. plants are more than a decade old, vs. 54% in China.

More innovation. Better goods. Lower prices. Newer plants. America will surely continue to benefit from China's expansion. But unless it can deal with the new industrial realities, it will suffer a loss of economic power and influence. Can the U.S. meet the China challenge?

China buys IBM PC Business – Automation next?

As a postscript to this review of the impact of China on the manufacturing scenario, consider this latest development (late 2004). That venerable standard "The IBM PC" is now Chinese.

In a deal that announced China's ambitions to become a key global player, Chinese manufacturer Lenovo is taking over IBM's PC business, including R&D and manufacturing. This creates the world's third-largest PC manufacturer (after Dell and HP), and changes the structure of global PC manufacturing. The deal, one of the biggest acquisitions ever by a Chinese company, is expected to quadruple sales of Lenovo, already Asia's biggest computer manufacturer.

There's a lot of pent-up money in China from its exports to the US and the rest of the world. Until now, US capital has been going in the opposite direction, pumped into China's booming economy. Despite a huge trade surplus, China has not yet put much direct investment into the U.S. It must start doing so soon.

Right now the Beijing government has tight control over conversion of the Yuan currency, which is pegged to the US $. At present, the Chinese government holds about 10% of outstanding U.S. Treasury securities, second only to Japan. Most people feel that the Yuan is undervalued by about 30% and a revaluation will devalue China's U.S. debt by a third. Unless it simply accepts a devaluation of this huge debt, China will surely be using this cash to do a lot more deals in the U.S.

Who knows – maybe even some of the major automation companies will soon be Chinese…