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Special Focus Interview: Shaun Rein and “The End of Cheap China,”

As part of our ongoing attempt to explore the changing sourcing environment in China, Sourcing Journal brings you an interview with one of of the leading thinkers on the topic. Shaun Rein is the founder and Managing Director of the China Market Research Group, as well as the author of the upcoming book “The End of Cheap China,” available March 2012.
Check out other premium Sourcing Journal articles about China:
Foxconn Raises Wages — Will Apparel Follow?
China’s 12th Five-Year Plan Details Changes to Textile Manufacturing
Where’s the Next China?

SJ – Rising labor and real estate costs are forcing low-cost Chinese manufacturers to close, relocate, or move up the value stream. First, what are some specifics on those conditions? Then, where are companies relocating and what happens to FOBs as companies relocate? We have the impression that the majority of companies are just relocating to the interior, but that this trend is not sustainable as far as maintaining low costs. Why?
SR – Two key problems are disrupting manufacturer’s production lines in China.  First, wages are soaring. For example Foxconn, which makes many of Apple and Dell’s products, raised their average salary by 66% last year. They are not alone in facing labor cost increases as 21 of China’s 31 provinces raised their minimum wages by 22% in 2011. Companies from LG Electronics to Honda have faced worker strikes because they are demanding higher pay.  Second, there simply is a dwindling labor pool size. Many younger Chinese no longer want to work in factories, and there is also an aging population because of the one child policy.
Many companies have tried relocating production to lower cost areas like Indonesia and Vietnam where salaries are a fraction of those in China. This works for light industry like clothing. However, I track a company in my upcoming book “The End of Cheap China” that moved major operations to Indonesia and actually relocated much of them back to China because China’s labor pools are far more efficient, infrastructure is world class, and quality control is better. The result is manufacturers will either have to move up the value stream, transfer higher prices to end consumers (which could cause global inflation) or take squeezed margins. Most likely, all three will happen simultaneously.
No matter what happens, the end loser is the American consumer, who will face higher prices and potentially fewer product SKUs on the lower end.

SJ – You say China is shifting from exports to domestic consumption, and rising incomes will create opportunities for foreign brands to sell products in China rather than just producing there. Is this true throughout China, or only in the coastal megacities? Will products being sold by foreign brands continue to be produced in China? How much more can we expect incomes to rise before China becomes a victim of its own success like the United States?
One of the greatest growth stories in the next five years will be the Chinese consumer. My firm estimates retail sales will grow 16% annually in China for the next five years.  Already, China has become the largest market for Intel and Bentley.  It is now the second largest market for Apple, who saw their sales quadruple from $3 billion to $12 billion between 2010 and 2011.
The manufacturer I mentioned that relocated back to China found that it could not transfer higher prices to American consumers.  Price sensitivity has become too great during the Great Recession.  Instead of taking a haircut on profits, they decided to convert production lines to actually sell into China. My book shows them converting factory lines to sell in China and gives tips on how manufacturers can do that.

SJ – How is China’s shifting economy affecting global commodities markets? Are high prices likely to persist indefinitely, or are they simply a temporary aberration until more commodities production comes online? How is this influenced by China’s nationalistic approach to commodities acquisition?
We are just at the start of the Chinese gobbling up more commodities. Compared to the US, few Chinese have air conditioners or cars.  Houses are one-tenth of the size of American homes. As incomes rise in China, you are going to see more price pressure on commodities the Chinese want — from iron ore, to copper to oil.
To ensure China’s demands are met, more state-owned enterprises will make multi-billion dollar investments throughout the world to shore up supplies. This will naturally cause friction with many countries, so China needs to improve its soft power strategy.  I am also concerned about rising tension in general, and worried that this could lead to trade wars. In 2012, we are seeing an election year in the US and a leadership transition in China — I worry some politicians will use fear-mongering to gain support. Hopefully cooler minds will prevail.
SJ – When China’s consuming class rises, it’s logical to assume that foreign brands will begin selling more extensively within China. Do think mid and low range sourcing companies will also be able to sell more extensively within China, or do you see China primarily developing a market for higher end goods?
Right now consumption in China is shaped like an hourglass.  Consumers want the high cost goods at the top, like a Louis Vuitton handbag, and the cheap things at the bottom. You see secretaries making $800 a month, buying $1000 Gucci bags, but riding a bike to work.  They only spend where they see value. Brands in the middle, like a Gap or Marks & Spencer, are getting killed because they don’t offer prestige or savings.  I see a difficult road for them in the future.
I would not recommend competing in China on price.  You really cannot beat Chinese firms on prices as not all adhere to international standards.  China’s shift from an export oriented to consumption oriented society will provide huge benefits for foreign brands, but they must take the right strategy or they will end up retreating from the market as Best Buy and Home Depot have done.

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