Colin Benjamin, Mentor

Are there downsides to manufacturing our product in China?

Colin Benjamin /

We’re working out how and where to manufacture our product. I hear lots about how China is the only real option and that everyone’s going there.

 

But are there any downsides to this approach?

 

I’m a bit worried about the distance/communication issue. Or is this just not a problem?

 

It is certainly true that rapidly changing demographics, rising incomes, increased consumer spending and an increasingly open business environment have all helped to make the Chinese market increasingly attractive to Western businesses across a variety of industries.

 

While it is still a great option, it is not the only one.

 

Similarly, lower labour costs and manufacturing expansions in China have encouraged many US and European companies to choose it as the centre of their long-term global growth strategies, although a range of Asian countries are now becoming very cost competitive.

 

China is certainly not the only option to consider for manufacturing and there are at least three major risks to consider, according to the International Country Risk Guide: Political, financial and economic.

  • Political risk includes government stability, socioeconomic conditions, investment profile, internal and external conflict, corruption, military in politics, religious tensions, law and order, ethnic tensions, democratic accountability, and bureaucracy quality.
  • Financial risk includes total foreign debt as percentage of GDP, debt service as percentage of exports of goods and services, current account as percentage of exports of goods and services, international liquidity as months of import cover, and exchange rate stability as percentage of change.
  • Economic risk includes real annual GDP growth, annual inflation rate, budget balance as percentage of GDP, and current account as percentage of GDP. Each of these elements needs to be considered before believing the canard that “everyone is doing it.”

Their findings are that success is greater with earlier entry, greater control of entry mode, and shorter cultural and economic distances between the home and the host countries. Importantly, with or without control for these drivers, firms have less success in India than in China.)

 

According to our own Chinese market entry team, there are certainly downsides or at least significant challenges that a new entrant to China should consider. Many of the top 500 companies have established a presence in China and many have paid significant entry fees.

 

Small companies have proven more successful than larger ones that have attempted to establish business in China. But while there have been many successes; there have also been many failures.

 

Distance is not necessarily a major issue. However, communication or lack thereof can lead to debilitating corporate dysfunction. When considering any country in which to establish manufacturing supply, it is essential to be cautious unless you, or a trusted partner, speak the language. A cultural awareness of the country is also important.

 

If you decide to go to China, there are often problems with business establishment through engaging with inappropriate Chinese speaking partners or employees who promise easy entry but disappear when the going gets tough. As an example, Indonesian, Malaysian and Taiwanese Chinese that speak Mandarin are not necessarily culturally accepted or necessarily appropriate to do business in China.

 

This can also be the case with Chinese that have lived overseas for a long period of time or have no experience with manufacturing and only a background in import and export trades.

 

Our team suggests that you may wish to consider the following issues:

 

Issue

Possible impact

Lack of understanding of cultural practices

Lack of stable relationships with staff, suppliers, local authorities, etc.

Lack of understanding of the business mores

Finding it difficult to establish productive business relationships.

Understanding business law

Problems with compliance

Understanding administration

Administration requirements and responsibilities in Asia differ significantly from Australia and require specialist local knowledge.

Reporting requirements

  • Monthly reporting
  • Annual checkups
  • OH&S
  • Tax

Your business license could be cancelled if reporting does not meet expected standards.

Structuring to facilitate repatriation of profits

If not properly structured you may have difficulty transferring earnings overseas.

Selecting the appropriate area of zone to establish your business

Relates to tax benefits, etc

Human resource issues

This is a minefield if not properly managed which could cause you to spend an inordinate amount of time and energy in arbitration courts.

Controlling the procurement process

If not controlled your costs escalate.

 

Research suggests that entry strategies that involve high control (e.g., wholly owned subsidiaries) are more successful than those that involve low control (e.g., licensing).

 

For example, in China, FedEx, which operates as a wholly owned subsidiary is more successful than UPS, which operates as a joint venture.

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