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Opportunities for Action in Industrial Goods
Made in China: Why Industrial
Goods Are Going Next
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Made in China: Why Industrial
Goods Are Going Next
Shopping at Wal-Mart in the United States or at
Carrefour in Europe will give you the wrong idea
about where China’s threat to U.S. and European
manufacturing lies. Most made-in-China consumer
goods on those shelves represent industries that left
the United States and Europe years ago. A major
study by The Boston Consulting Group, currently
under way, suggests that the real contest between
Western and Chinese factories is taking shape over
industrial goods—a $2 trillion market whose products
range from small motors and oscilloscopes to locomotives. For goods such as these, the West’s muchvaunted technological edge and resulting productivity
advantage have kept production safe at home—until
recently.
Today China’s rapidly growing capabilities and huge
scale are undermining these defenses. The cost advantages of moving production to China can amount
to savings of an astonishing 20 to 35 percent—with no
loss of quality. Numbers like these are persuading
manufacturers to transplant to China even high-performance, highly automated product lines, such as
micromotors and medical-imaging machines. Many
more will follow.
How China Is Doing It
How is China managing to compete so effectively
against Western factories? Unlike Japan, which reinvented manufacturing a generation ago by introducing continuous improvement and quality programs,
China is de inventing manufacturing by removing capital and reintroducing skilled manual labor on the
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plant floor. China’s low costs—not only for production workers but also for plant technicians, accountants, and managers—allow Western companies to
rethink every business process, from how a product
and its parts are designed to how they are made, tested, packaged, distributed, and even supported in the
field. The results—in addition to cost savings—are
more craft, less complexity in plant processes, and
often a shorter time from design to production.
And then there is the vast potential of the Chinese
market. China is already becoming the world’s largest
market for some industrial goods, such as machine
tools and power equipment. Add to these advantages
the improving quality of materials and the reliability
of supply chains in China—including sophisticated
transportation and third-party logistics—and it’s little
wonder that some U.S. and European companies are
moving entire core product lines there.
But many are not. In both the U.S. and the European
industrial-goods markets, China is still small fry. In the
United States, China accounts for just 3 percent of
industrial goods sold. Domestic production accounts
for 70 percent, imports from Japan and Western
Europe another 20 percent, and imports from lowwage countries, including China, just 10 percent. In
Europe, China’s penetration rates are even lower. In
Germany, for example, imports from low-wage countries account for just 6 percent of the industrial goods
market, and China’s penetration is 2 percent. Why
have so few industrial-goods companies thus far
turned to China for manufacturing?
Why Some Companies Are Holding Back
Some Western companies have found China’s cost
advantage elusive. In a number of cases, their initial
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approaches—sending buying teams to China, armed
with drawings and specs, to search for low-cost
sources—haven’t worked out. Producers of small
engines and low-end farm equipment, among others,
recently explored the possibility of taking production
lines to China but found that uneven quality and
unreliable supply lines outweighed the advantage of
lower production costs. In their view, the money they
would have saved on manufacturing just wasn’t worth
the higher technical- and inventory-support costs, in
addition to the risks.
From a short-term point of view, their decision makes
sense. Sourcing in China takes time. It works best for
companies that are willing to invest their own knowhow and nurture their China operations over sustained periods. So far, only a limited number of foreign industrial-goods manufacturers, such as Atlas
Copco in compressors and Emerson in motors, have
made this kind of commitment. The lessons they are
learning can be instructive.
How Committed Companies See
a Different China
Our research shows that companies committed to
large-scale manufacturing in China think about the
issues differently than their less committed competitors in several important ways.
Committed companies have a clearer view of the cost
advantages to be gained. Companies that are committed to manufacturing in China accurately assess both
the labor costs and the capital costs of their products.
Accounting statements may tell a finished-equipment
manufacturer that factory payroll represents only 10
percent of its costs; but in fact, when one adds in the
full payroll cost of the purchased components and
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company overhead costs, the total labor costs typically amount to 40 to 60 percent of the final product
cost. In China, those labor costs are lower across the
board. Production workers typically cost 5 percent
of their U.S. or European counterparts, whereas experienced engineers and plant managers may cost 35
percent.
But what about the difference in labor productivity?
True, U.S. and European workers in capital-intensive
factories can be several times more productive than
their Chinese counterparts. That’s because they work
in plants in which complex flexible-automation and
material-handling systems have replaced many factory
workers. This substitution has reduced labor costs—
but it has substantially raised the costs of both capital
and support systems.
Chinese factories reverse this process by taking capital
out of the production process and reintroducing a
greater role for labor. Parts are designed to be made,
handled, and assembled manually. This approach cuts
the total capital required by as much as one-third. So
although output per worker is lower in Chinese factories, the combination of lower wages and a lower capital investment typically raises the return on capital
well above Western factory levels. Some manufacturers have beaten their cost-saving estimates by 15 to 20
percent and report return on invested capital of 50
percent or more at mature plants.
Western companies that develop several factories in
China—as, for example, Kodak and Copeland have
done—will see more cost savings than a competitor
taking its first steps, for several reasons. These companies work with and improve their local suppliers.
They teach their Chinese engineers the quality disciplines. And they become skilled at hiring good people and designing effective incentives. The benefits of
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manufacturing in China increase with scale and experience there. The more you grow, the easier it is to
continue growing.
Committed companies understand which products to
shift to China. Counterintuitively, it usually makes
more sense to send a distinctive new product line to
China than an old, price-pressured one. The payoff
from sending the latter to China is low. The many
one-time expenses—redesigning products and processes, sorting out new local suppliers, and requalifying
the new finished product with customers back in
home markets—could wipe out any profit margin. In
addition, moving existing product lines often forces
companies to close down production lines in home
countries—a process that is painful at best, especially
in Europe.
In contrast, designing a new product for manufacturing in China can make a lot of sense, particularly if
the company is far along on its experience curve
there. For instance, Tektronix’s new oscilloscope was
designed by U.S.-based engineers working virtually
with their China-based tooling counterparts. Because
the product was designed for production in China
from its inception, the company will have only one set
of start-up costs and a lower capital investment to
amortize.
Committed companies make more realistic assessments of the risks involved. Outsiders often exaggerate China’s supply-chain risks. Similarly, China’s production tends to look more secure to insiders than to
outsiders. For example, China demonstrated its fundamental resilience early this year when the outbreak
of severe acute respiratory syndrome, or SARS, caused
few supply disruptions. And Chinese authorities regard foreign-owned plants as valuable assets not to be
disturbed.
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But some risks are not exaggerated. The need to
protect intellectual property rights, for example,
deters many companies from taking highly proprietary processes to China. Armstrong, the world’s
leading floor- and ceiling-tile manufacturer, keeps
some material formulas and processes in the United
States. AMP, the world’s leading producer of connectors, had no choice but to move to China because
of the cost savings involved. So AMP conducts its
proprietary inline-plating process in China in a
specially designed, secure enclosure with licensed
employees. Other companies accept the risk of
some leakage of intellectual property in return for
China’s many advantages. Auto companies, for example, know that some of their technology is migrating to their Chinese joint-venture partners; but in
return, they get a head start in China’s exploding
market.
Committed companies understand the implementation challenges—and how to overcome them. Many
companies have been attracted to the benefits China
offers but have not been able to realize them, often
because of organizational barriers. These obstacles
include organizational mindset, communications
challenges, resource issues, the need for complex
coordination, and a lack of incentives. Successful
companies have overcome those barriers in a variety
of ways. Their approaches tend to have two things in
common. First, these companies invariably lead from
the top—as exemplified by Jack Welch at General
Electric, among many other CEOs who have made
this topic their own. Second, they set stretch targets.
Cost-reduction goals of some 10 percent force the
organization to consider relocating manufacturing to
low-cost countries, such as China. They provide a
powerful incentive to break through organizational
inertia and resistance.
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The Bottom Line
Not all products will or should move to China. Products for which customer-driven innovation is frequent
and critical will not go there. Nor will those that
require extensive customization involving intimate
user contact with the factory. In addition, a number
of products may stay at home for political reasons.
Some Western customers, especially publicly funded
organizations, will insist on buying only goods that
have been produced in their home countries. As
more companies discover the advantages of manufacturing in China, the impact on Western jobs will grow,
making it an increasingly potent political issue.
In moving manufacturing to China, the most daunting barriers will be the customer-related and organization-related factors mentioned above, not technologyrelated ones. Production technology is often surprisingly mobile and divisible among locations. Large
quantities of leading-edge medical diagnostic equipment are now being made in China. Jet aircraft
engines—which are already being overhauled and
maintained in China—will soon be manufactured
there as well. There are many reasons to make more
things in China.
* * *
Although China today has only 3 percent of the
industrial goods business in the United States and
even less in Europe, its shipments to those regions are
growing very rapidly—at more than 20 percent annually—in a market that is essentially flat. Over the next
several years, the pace of China’s continuing penetration of Western markets will be governed not by anything as simple as wage increases or exchange-rate
revaluations but by the increasing capabilities of for-
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eign-owned and operated plants in China. Industrial
goods companies that are not already sourcing and
manufacturing in China should be giving this opportunity very serious consideration.
Jim Hemerling
Thomas Hout
Jean Lebreton
Jim Hemerling is a vice president and director in the
Shanghai office of The Boston Consulting Group. Thomas
Hout is a senior adviser in the firm’s Hong Kong office.
Jean Lebreton is a vice president and director in BCG’s
Shanghai office.
This article is based on “The Real Contest Between America and
China,” which appeared in The Asian Wall Street Journal on
September 16, 2003. It is adapted with the permission of The Wall
Street Journal, Dow Jones & Company, Inc. All rights reserved.
You may contact the authors at:
[email protected]
[email protected]
[email protected]
© The Boston Consulting Group, Inc. 2003. All rights reserved.
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