Podcast #52:
Profitable Growth Podcast
Supply Chain Management: Part 8 of 9
Transcript:
By Jim Tompkins, CEO, Tompkins Associates
Jim
Hello, my name is Jim Tompkins, the CEO of Tompkins Associates and Tompkins International.
I am pleased to be with you today to present the eighth part of our podcast series on Profitable Growth.
Throughout this series, we've been working through the numerous ways that effective supply chains and good management can create and sustain profitable growth. Today we will turn our attention to the very popular topic among executives, China.
With us today is Kent Kedl, General Manager of our China-based firm, Technomic Asia.
Jim
Kent, China is at the top of every business leader’s mind these days. So in our series on profitability, I assumed that China would figure in somehow. Am I right, or is this going to be a very short Podcast?
Kent
Well, it turns out that you are very correct, Jim. I think the reason that China is on the top of everyone’s mind these days specifically because a successful China business can be a HUGE contributor to a company’s overall profitability. Not to over-simplify things, but I think there can be three ways that China plays into a company’s profitability:
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China can be a good source for cost savings
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China can get a great place to find new growth opportunities which, ultimately, can contribute to profitability
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In China, we’ve found that companies can do what we call “climbing the bill of material.”
Jim
Those sound intriguing, Kent, particularly that last one. Let’s take them in order. I suppose that your first point, that China can be a good source for cost savings, is what we all think of when we think of China. Is it that simple?
Kent
Well, I wish it was that simple, but no, it’s usually not. The operative phrase here is that China “can be” a source of cost savings. I use that phrase very purposefully here, Jim. Too many companies think that they can move manufacturing over to China and instantly see a 40% cost savings, a savings that, according to some voodoo accounting, drops nearly completely to the bottom line. There are a couple of areas that are no-brainers for cost savings (and, therefore, enhanced profitability):
Labor costs: China still can be a significant cost savings for labor, often one fifth of the costs in the U.S. and even more in Europe or with union labor. For example, a line worker in a factory in the Shanghai area makes, on the high end, makes about $350 per month, salary and benefits. An engineer will make $2,000 and an experienced manager will make $4,000 per month. Go outside of Shanghai, and you might see an additional 30% lower cost in some of the smaller cities. So on a line item comparison; these are significant savings over Western operations
Factory costs: It’s actually pretty easy to spend a LOT of money on setting up an operation in China, if you spec it out the same as the operation you have in your home operation in the U.S. or Europe (the same equipment, the same infrastructure, etc.). However, you can localize your factory costs here and same up to 50% for “good enough” equipment. Of course, if your operations require very specialized equipment, this will not apply, but we find that many companies can see some very good cost savings in their factory costs.
Logistics: One of the main reasons that companies set up in China is to serve the China and broader-Asia markets (and we’ll get into this in point #2). Shipping costs – particularly for big and bulky products – can be quite high and import duty rates are not always favorable. Making closer to your customers is often a great contributor to profitability.
Jim
OK, Kent, you said cost savings “can be” helpful and you’ve made some good points, but I feel a significant “however” coming along here. When might China NOT be a source of cost savings?
Kent
Well, let’s just take two input costs as an example. Labor costs are good on a one-to-one comparison as I’ve just done. However, we often find that, with China still a “young” operational environment, that one person here does not necessarily equal one person in a company’s home environment. For example, we’ve heard that labor efficiencies here can be half or even a third as good as those in the West, depending on the job required. That means that your raw labor rates need some adjusting when you run your costs.
Another input cost that is not necessarily better here in China is raw materials. For some materials that can be made locally, you can get some good prices here. However, there are still a lot of materials that need to be imported – specialty chemicals, precious metals and high end petroleum products, for example – and those costs can actually be higher here than in the West and the supply capacities can often be constrained.
The net of it is that while China can be a good contributor to profitability through cost savings, companies should really do their homework before moving operations over, pell-mell. Research input costs for your industry, benchmarking competitors and other market players. We do many of these types of programs every year and find that, while savings can be real, they are not always in the places we thought they’d be and we needed to adjust our operations plan.
Jim
OK, good caution. Let’s move on to your point number two. I get that growth is important, but this Podcast is on profitable growth. Connect those two for us, if you would.
Kent
Right. The problem with cost savings is that your customer is never satisfied! Say that you moved your operations to China and you DID find a way to save 30% on costs and were able to pass some of that on to your customer. Are they going to say “thank you very much for that, you don’t need to do any more, I’m satisfied”? No! They are going to say thank you very much today and then ask what you have for them tomorrow!
So a company needs to look for growth opportunities to sustain their profitability. A great test of your company’s health is to run an assessment of your sales every year, how much were to existing customers and how much was to brand-new customers. I know that you want to keep customers for life so “selling deep” is critical (and can be quite profitable once you’ve spent on the initial cost of acquiring a new customer). But you are not going to be able to sustain yourself this way and so you are going to need to find new customers. And not to over-simplify things, but with the economies of North American and Western Europe still in the doldrums, one of the best places to look for new customers is here in China where many industry sectors are growing at double digit rates.
So to not only get more profitable but to remain profitable, you need to be constantly finding new customers. And to relate this to my first point on cost savings, although the conventional wisdom might say that foreign companies’ primary motivations to come to China is to save costs, this is not the case. The American Chamber of Commerce in Shanghai has done annual surveys of their members every year for the past 10 years and the majority of companies (we are talking 60% of them) say that they are in China primarily to go after the China market. So they are able to realize the cost savings here but they are using it as a jumping off point. And even in 2009, a very challenging year for everyone, 65% of the companies surveyed by AmCham reported that they were “profitable” or “very profitable”. That’s not too bad!
Jim
That is encouraging, Kent! I would imagine that 2010 is going to be even better. But let’s get to your point #3 because I’ve been dying to ask about it. What do you mean that companies can become more profitable by “climbing the bill of material”?
Kent
Well, let’s think about it. Many companies out there are suppliers of parts to larger manufacturers or OEMs. We call them Tier 1/Tier 2 suppliers. These suppliers make a sub-assembly or just a component that is part of a larger bill of material. We have found that companies here can find ways to “climb the Bill” in that they are not only able to supply a component to their customers, but they can often go higher and provide the entire sub assembly, and that can be highly profitable!
Let me give you an example, we had a client who was a supplier of hinges for laptop computers. These hinges attached to a frame that was incorporated in the screen and keyboard assembly. Traditionally, they just supplied the hinges which were manufactured in the U.S. and shipped cheaply and efficiently to their customers operations in China. But one of their customers here asked if they could supply the metal frame as well, now this was not something they could do from the U.S.; it was too bulky and inefficient to ship. But our customer found that they could set up an operation here to take the hinges made in the U.S. and assemble them here in China along with the frame which they bought from another supplier. They not only increased their revenues but they also greatly improved their margins.
Now what makes this possible in China is that these larger companies are (the OEM customers) ALL looking for good suppliers, and once they find you, they are going to be very open to your doing more and more for them. Certainly, the costs are going to be competitive and the sale will not be a slam-dunk, but we encourage all of our mid-tier manufacturing clients to really expand their thinking and try to find ways of adding on capabilities. The results are ALWAYS a nice impact to the bottom line.
Jim
Very interesting, Kent. That’s some good advice. Any final thoughts that you’d like to leave with our listeners on how China can contribute to their profitable growth?
Kent
Just this, Jim, none of the things I have recommended are a “quick fix” to profitability. Unfortunately, we too often see companies wanting to use China as the cure for all of their ills. And it just doesn’t work that way. China needs to be approached VERY carefully and by following what we’ve called “The Six D’s: Due Diligence, Due Diligence, Due Diligence!” Leaders need to take a long-term view of opportunities here. If they do, we are very confident that they will see China as a huge contributor to their profitability, and sustainable profitability at that!
Jim
Thank you Kent. I love it, ‘The Six D’s’. Very good advice for our listeners.
Join me next time as we conclude our podcast series on Profitable Growth. Gene Tyndall will be with me wrapping up. Speak to you real soon.
Visit Jim's blog, GoGoGo!, at http://gogogosupplychain.tompkinsinc.com/
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