Adjusting to the New Normal
The sourcing landscape in China has fundamentally changed due to recent global and domestic trends. Once considered the workshop of the world, the Chinese economy successfully managed the transition to a more advanced stage of development. Many call it “the new normal”: higher wages and a strong RMB have driven up production costs, while global demand is down. But the outlook is not bad: wage increases have fuelled investment in more efficient production. While only 5 years ago some buyers’ sentiments about China were rather negative, in 2015 things are not quite that bleak. On the contrary, China offers relative political and social stability and mature suppliers, especially compared to its Southeast Asian neighbours.
As everyone adjusts to the new normal in China, there are a number of new concerns for foreign companies sourcing from here, especially when it comes to pricing and securing timely deliveries. Nonetheless, China will remain an attractive sourcing country for many of Fiducia’s clients in consumer industries due to its massive production capacities, mature supply chain of materials and technologies, and sophisticated infrastructure. Chinese manufacturers offer a wide range of quality levels and large assortment of products with several decades of experience, which cannot be taken for granted in this region. While some companies are increasingly considering a multi-country sourcing strategy, China will remain a key sourcing location, especially for those who seek a reliable and stable supply chain.
Due to the rapid depreciation of the Euro in recent months, many of our clients’ European customers are asking for discounts in order to adjust to the unexpectedly more expensive prices. However, production is increasingly costly as well, leaving many companies in an awkward position. Many have adopted a wait-and-see approach, waiting for the first retailer to ultimately increase prices, triggering a reaction from others facing similar cost increases. Others have explored various ways to alleviate the cost pressures, especially as these increased costs are not equally shared among Chinese suppliers. Most of these will accept not to increase their prices or only implement smaller increases, while a select few will even accept cutting prices. In our experience, most manufacturers are aware of the cost pressures of their customers and are willing to lower their own margin expectation.
How can I cope with this?
Companies should examine various elements in their supplier relationship and collaborate with them to build trust, obtain better prices, and secure production priority. Fiducia has actively supported clients in implementing new sourcing strategies, as the ones below:
Financial measures: as the RMB grows stronger, some of our clients have protected themselves from unexpected or dramatic changes in currency exchange rates with currency hedging. Others have switched to RMB payments and reported a 3-5% price reduction. In addition, companies can help key suppliers improve their cash flow by offering shorter payment terms and higher advance payments in return for some price concessions.
Supplier partnership: companies should seek out “best-fit” suppliers who will assign a high priority for their orders. In today’s China, established suppliers are equally as selective of their customers as their customers are toward them. Some of our clients have incurred losses in revenues and reputation due to ill-selected suppliers, who over-promised and gave priority to other customers during peak production seasons. In addition, companies should maintain a longer-view in the supplier relationship and gauge if the manufacturer is committed to investing further in its production capabilities. Many Chinese entrepreneurs have lost interest in manufacturing and instead pursue higher and quicker returns in real estate and other investments. For a good working partnership, companies should explore ways to help their suppliers become more efficient, for instance by collaborating with them on helping them best utilise their resources and minimise rush orders.
Strategy assessment: in the past, smaller manufacturers were inexperienced in foreign trade and many companies still purchased via trading companies. Times have changed and today most manufacturers are capable of communicating and working with foreign buyers directly. Going straight to manufacturers and cutting out middlemen who do not add distinct value could bring substantial cost savings. To provide incentives for lower prices, companies may consider consolidating their orders to a few key suppliers and renegotiating purchase contracts by offering bulk orders.
As the global sourcing landscape continues to evolve, companies are increasingly organising their sourcing activities strategically across countries. For instance, some of our clients have relocated part of their less labour-intensive, low-scale production to Eastern Europe. Other clients have moved their footwear and garment production to Vietnam, Bangladesh, and other Asian locations. However, for specific sectors a fully integrated supply chain with high capacity and lower costs only exists in China. Our clients producing toys, electronics, home improvement products, and technical textiles, for instance, have not extended their supply chain beyond China. Most Fiducia clients have used the Hong Kong platform for trading with other countries within the region.
What is the Chinese government doing to help exporters?
As Premier Li said, “China has many tools available in its policy toolbox.” One primary instrument China often uses to influence exports is the VAT-rebate policy. As the country faces downward pressure on its economy and slack export demand, the Chinese administration may yet again adjust the VAT rebate rates for some of the industries to encourage exports. The latest example was the increase of VAT rebate from 16% to 17% for selected textile products, making it a full rebate.
The internationalisation of the RMB will continue to facilitate cross-border trade with China, especially with its regional neighbours. An internationally accepted RMB offers substantial opportunities and convenience for both Chinese exporters and foreign buyers in trade and investment.
China has so far signed and implemented 12 Free Trade Agreements, with another 20 in the pipeline. The FTAs with trading partners like Switzerland and ASEAN will improve competitiveness of Chinese manufacturers in these markets. Many of our clients have also expanded within ASEAN and we have supported them by finding the right talent to run their operations.
Another policy tool to improve trade opportunities for foreign companies and facilitate customs is the nationwide setup free trade zones. Besides the launch of the Shanghai Pilot Free Trade Zone in 2013, the government plans the establishment of three additional Free Trade Zones in Guangdong, Fujian and Tianjin.