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William E. Connor Talks Sourcing in Struggling China

It’s no secret the world’s second largest economy has floundered in recent years, and scaling back on sourcing in China is a topic companies love to bandy about, but it has little weight when considering one simple fact: China may be in a bit of a rough patch, but the Asian powerhouse isn’t going anywhere.

And W.E. Connor, chief executive officer of Hong Kong-based global merchandise sourcing organization William E. Connor & Associates, knows a bit about sourcing in China—more than half of the company’s business still comes out of the country.

Sourcing Journal caught up with Connor, who explained why costs in China are rising, why the country’s economy is slowing and how, despite that, much potential remains to be tapped.

SJ: Given the news regarding the economic slowdown in China, what’s your outlook for business there? Will it still be the go-to sourcing locale?

WEC: China is very definitely slowing and my own take is that the economy is probably worse that the topline numbers suggest. It’s going through an incredible period of structural adjustment. It’s moving more to a consumption-driven economy. When we look at China, retail is soft and the economy is not good. At the end of the day, you’ve got this $10 trillion economy that’s gone from double-digit growth rate to single digits. The high rates of growth were unsustainable. Yes, they’re lower, but 5-6 percent of a $10 trillion dollar economy is still very substantial growth.

Where does this leave China going forward? We [W.E. Connor] are in 21 countries around the world and when you look at our company, China still accounts for about half of everything we do, maybe a little less than half. China is not just the Pearl and Yangtze River Deltas where so much production takes place, it’s really a vast and very diverse country. You’ve got lots going on on the coastal side, but increasingly in the interior.

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There’s a tremendous amount of remaining potential in China’s interior. You can get a container from Chongqing to a coastal port more efficiently than you could five years ago. We’re witnessing a gradual migration of business to the interior and where we’re putting offices in China is changing a little bit.

All else aside, China remains a country of 1.3 billion people—the total population of Southeast Asia is about half or less that of China. China by its sheer size is going to remain important.

SJ: With costs on the coast rising, how much of China’s manufacturing is moving inland?

WEC: There are a number of reasons for the move inland. The simplest takeaway is that things are expensive on the coast—land is expensive, wages are very high. Also, the provincial governments are trying to get the manufacturers to trade up the value chain. There is pressure on the part of manufacturers to try and add value.

So you add to that that so much of the production in China has come from migrant workers, who don’t feel quite the tie that people native to that province might feel. China has a large population of migrant workers in the major cities. The Chinese hukou, or household registration system, is such that many social services—subsidized health care, education, pensions—are denied to these migrants who are non-local. As opportunities grow in China’s interior, there’s an increasing disincentive for people in the interior to come and live in the coastal areas. If you set a factory up in Chongqing, most of those workers are, by definition, “local” meaning they don’t come from somewhere else. The social dynamic of China is changing more from migration to people staying in their home provinces.

So, while we’re seeing less worker migration to the coastal areas, production in coastal areas. Where know-how, worker skill, knowledge of the customer, quick turn, speed and flexibility are generally concerned, the Pearl River Delta, the Yangtze River Delta are going to be increasingly important.

The challenge for us is we need to have boots on the ground in all of those areas hitherto that we might not have been in before.

SJ: What’s the status of the country’s labor shortage? Did workers return after Chinese New Year?

WEC: Our impression is that it was basically the same as it has been in past years. I’m guessing the return rate was around 90 percent, which is close to what it has been. Shortages were bigger in the Guangdong area and along the coast near Shanghai, less so in the interior.

The shortages are caused by a lot of things. While a worker will get paid less in the interior, the cost of living is also less. There isn’t much of a cost with workers staying in their home province. Labor shortages are more in traditional producing areas.

SJ: Are factories seeing orders up, down, flat?

WEC: Pretty flat if not down, just as a general statement. Things are very tough. There has been tremendous pressure for factories. Many factories quietly close in the middle of the night because they can’t make a go of it anymore.

We’re seeing some of our own clients holding back on placements compared to last year, which translates to fewer orders for factories.

SJ: Are Chinese manufacturers investing internally or looking to spend money on overseas companies instead?

WEC: Yes and yes. Investment also means the set-up of factories in areas that are more cost effective, notably away from coastal provinces. We’re not seeing a rush anywhere, we’re not seeing massive offshore investment, but there has been some investment in fabric mills.

It’s kind of the nature of the beast. When you accumulate wealth in China, you go out and buy property. We’re not seeing many manufacturers go out and buy scale. If they’re going to work on small margins, they want to see large production runs, long-term commitments, that sort of thing.

SJ: Do you think China will enter the Trans-Pacific Partnership (TPP)? If so, what’s likely to change for the country?

WEC: TPP is not a done deal. I just think trade agreements are a good thing, and the more participants you have are a better thing. The fact that China isn’t in it isn’t good for us.

For us, probably the main beneficiary is going to be Vietnam. We’re seeing more mills going up in Vietnam and Vietnam looms large as far as being a beneficiary.

But how can you ignore the second largest country in the world [China] in terms of being included? My answer is, you can’t. But you have to take small steps before you take big steps. I think there will be inclusion of some sort. For now, the 12 participants will remain 12 and hopefully any agreement will get passed by Congress.

Long-term, China cannot not be in there. In addition to being a huge producing country, it’s growing as a consumer country. Most of the other signatories are mainly producing countries, with the exception of Japan and the U.S. Having China into that nexus will have the second largest country in the world’s consumers. When that will happen, I’m not sure, but I think eventually China, in one way or another, has to be part of a greater free trade dynamic.