An ASEAN sourcing comparison between China and Eastern Europe is not a simple calculus. A case based analysis of the current state of affairs highlights the various considerations.
For the past several decades, China has represented a lucrative option for multinationals to outsource manufacturing for high value added, labour intensive products due to low labour costs and a high standard of productivity. European and North American firms have located many of their production facilities in China, especially Eastern China as they attempt to service the Chinese and the ASEAN markets. But is this still a wise strategy? The following is a case based analysis of the current state of affairs.
The subject of this analysis is a German-based company that produces high-tech spare parts for gas and steam turbines for power plants in their production sites in Slovakia and China. Forced by cost pressures, and due to OEM customer requirements, the outsourcing of manufacturing to Eastern Europe was inevitable. Nevertheless, the close distance and low trade barriers in the European Economic Zone simplified the essential support from the headquarters. But the European market was not where the manufacturing growth and demand were. As markets developed in the emerging world, especially in China and Southeast Asia, the firm’s orientation turned more global. Soon, it became clear that growth in China was only possible with a local firm. Finding reliable local partners who were necessary to start operations constituted a major challenge in the beginning.
As China represented the fastest growing economy in the world over the last two decades, the need for power represented attractive opportunities for the power plant business. In the early days of the venture, improving skilled labour and infrastructure led to increased efficiency in operating processes and falling cost curves. However, in recent years, the firm has begun to experience enhanced red tape that has hampered the ease of doing business, especially when it comes to cross-border operations. The increasing administrative efforts and operating costs have led management to question if these drawbacks outweigh the locational advantages when supplying ASEAN. Recent improvements in Eastern European infrastructure and logistics capabilities increased the need for scrutiny of these long held assumptions. In this article we analysed the essential cost factors, direct and indirect, faced by a European-based MNC, to provide better insights and support for such decisions.
In analysing producer needs, the availability of goods and the number of suppliers play a key role. When there is a need for specialised, high-tech pre-products, firms in China have to establish their plants in more developed economic zones which lead to higher land and wage costs. Alternatively, if these products have to be imported from foreign countries due to a lack of local availability, import duties become an important concern. The variety, and reliance on domestic suppliers is relatively lower than in the European Union. In China, for many products, the anti-dumping clause is invalidated from the European Union for example. Moreover, the most favoured nation clause is also not applicable. Consequently, depending on the country of origin, the costs of imported intermediate products can command a premium of up to, or in excess of, 100%. In addition, the lead time these products need to actually get to the factories and passing border customs involves further time. In contrast, the access of Eastern European countries to the European Union brings along access to a broad range of specialised or unspecialised goods. Furthermore, the lack of customs within the European Union also reduces the administrative effort and leads to shorter lead times.
For manufacturing, it is important to know the role that labour plays in the value adding process and the cost structure. Over the last ten years, we observed that wages have increased much less in Eastern Europe than in China. In Eastern Europe, the wages have increased roughly 25% in the last ten years. In contrast, wage levels in China have increased by 150%. Ten years ago the costs for higher skilled blue-collar labour in Eastern Europe was around 110% higher than in China, nowadays this figure has decreased to under 50%. It is important to note that, within Eastern Europe you still face different stages of development. More developed countries like the Czech Republic or Slovakia provide higher skilled labour and much better infrastructure than some of the less developed countries like Romania or Belarus.
As Eastern Europe approximates Western European labour laws, the flexibility has been reduced. Concepts such as parental leave for fathers, strict 40-hour work weeks, four weeks of yearly holiday and multi-year severance considerations have changed the employment landscape and limited flexibility to ramp up and ramp down for cyclical products. Normally, such developments would sway a firm towards China as a production hub. A major advantage of Chinese blue-collar workers has been the flexibility in severance policies, working hours and unionisation. But, the latest generation of blue-collar workers in China has also changed compared to their predecessors. They are better educated in health and legal issues, collect greater overtime pay, and therefore focus more on their work-life balance. But still working overtime is seen as normal and holidays, except for Chinese New Year, are more or less optional. In the end, the flexibility compared to Eastern European countries, is greater.
Unlike labour costs, the protection of intellectual property rights in choosing a source of production tends to favour Eastern Europe. Eastern European members of the European Union have mostly harmonised their rights for intellectual property with EU standards providing greater certainty. In China, the protection of intellectual property rights is still in transition and remains highly cost intensive to maintain. Moreover, it lacks quality controls to affect either the supply of primary products, including raw materials, or finished goods of the companies. This quality control shortcoming can be related to the brief history of manufacturing higher quality products. Therefore, when the quality of materials and semi-finished goods play a significant role, purchase from foreign countries is sometimes unavoidable. The management and overall understanding of quality standards will need some time in the future to meet European standards. An option is to outsource quality control to foreign experts, but that results in a relatively strong increase of costs.