The Problem of China


When we discuss on shoring, the elephant in the room is always the People’s Republic of China (PRC). China’s economy is slowing fast enough to raise the issue of its future direction. The PRC has had a good run as a low-cost manufacturer with decent product quality, but labor costs have risen drastically over the last decade making the country vulnerable to re-sourcing decisions that take into account the logistics costs and risks associated with long pipelines.
From a nation-state perspective, China is a poor partner. Trade is very one-sided and, despite promises to open up, most companies find doing business in China very difficult. The state and party require large portions, usually a majority, of ownership to vest into their hands directly or indirectly, while treading through bureaucracy is a nightmare. In the long haul, China’s success is unsustainable on this basis alone, especially with labor costs quadrupling in the last decade, bringing costs close to parity with low-wage areas in the US.

The electronics industry, including mobile phones, computers, and consumer durables, has migrated much of its manufacturing base to China over the last decade. This was a result in part of the lower Chinese labor costs, but a significant contributor was the ability of Chinese companies to operate on very thin margins. While U.S. companies, and especially mature large corporations, run with fat staffs, the ODM focus is on high-volumes and thin staff head-counts.

To put this in perspective, a couple of decades ago, I ran the PC division of a major company with just 30 people in operations and engineering, compared with my neighbor, IBM, with 7000 in engineering alone. They generated 10x my revenue, but made little profit. Another example, a major PC maker moved to a costly part of the U.S., built a huge HQ and hired four layers of management with vice president in their title. They no longer exist and that excess overhead is what killed them.

The South China Sea situation and all of the tensions around hacking point up the fact that computers are a strategic resource for developed countries. Good sense would have manufacturing and assembly capability at least partially on-shore to protect against political disruptions.

There’s a good chance that, irrespective of the China Sea issue, China is facing serious economic disruption for a while which could make on-shoring viable, but these things are cyclical and preventing a return to off-shoring requires some radical thinking on what electronic products we make and how the businesses assembling them are run.

First, let’s tackle the “what” part of the equation. We are hitting a sea change in computer technology. For the first time, the CSPs have each focused on a few design centers that are mass-produced. This migrates the production target to one of low variability and high volume, and away from the highly variable models of the past. Designs are themselves simplifying. SSD and hybrid memory/CPU modules will reduce the component count in a server and make assembly robot-friendly. If these two key elements are made outside of China, as seems to be the current plan, we have a ripe opportunity for on-shoring the assembly process.
Companies such as Synnex, Sanmina, and Seagate’s Xyratex division all are experienced in configure-to-order fulfillment (they already do it for Dell, HP, etc.) so we aren’t starting from scratch. Unfortunately, they aren’t heavy into robotics yet, but labor content on the new designs should be very small and not the most pressing problem. The thought process of “regionalizing” manufacturing appears to be getting some traction as a way to speed up response to local market needs.

Though to China is the poster child for off-shoring, other countries contribute to the issue. India is the go-to place for call centers and software-on-a-budget, for example. There is evidence that many clients are not fully comfortable with off-shoring. As a result and with automation of commoditized tasks improving rapidly, the India model is changing to a hybrid where work is partially done on-shore as well. It may be that the large Indian service vendors own the on-shore efforts, too, but it does imply a reshoring of significant value.

This same issue of robotics may change the decisions in China too. A few years ago, FoxConn was talking up layoffs of over 1 million workers, with robots replacing them. As said above, the new designs should make robotics even more attractive. The question is where the robots go. With remote support one option, it may be a hybrid scheme where overhead and engineering is done in China, while robots are placed in the EU and US, but maintained from China. This reduces the serious risks of 12 to 16 week pipelines almost to an on-demand situation with little work-in-progress inventory and great agility.

Technologies such as 3D printing, digital manufacturing and IoT all improve the economics in favor re-shoring, while there is evidence that Chinese companies are interested in U.S. investment, with around $46 billion invested since 2000.

Overall, re-shoring has slowed somewhat in the face of the world economic weakness and he strong dollar. With a very acrimonious election facing them, we may see some leadership in Washington appear out of all the rhetoric on the subject. While the U.S. Congress is currently absent any action on the off-shoring of jobs, a few states have begun to place tough limits on the process. California, for example, is considering a bill to restrict public utilities from off-shoring, combining a job-protection goal with security for critical infrastructure

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