Low cost country sourcing : Is China loosing its shine?

Abstract

Cost Country Sourcing (LCCS), a strategy which aimed to leverage the low cost of production in developing countries, grew from being a competitive edge to become a necessity for companies to broaden bottom line by means of reducing costs. Now, companies beginning to relook into their decisions when the total landed cost is not only increasing but also becoming difficult to predict. The issue today is what factors went behind this phenomena and why we are at the verge of a new reality for next decade. Manufacturing competitiveness is central to success of an economy and this is true even for developed economies like United States. However, given the cost attractiveness of low cost countries, companies started to shift their manufacturing to countries like China and have finally resulted in the amount of global imbalances which we are witnessing today. We have presented our analysis to prove that how LCCS is not sustainable in future and has much higher costs for home country and reduces a company’s strength to compete in long run. In this report, we outline the factors which were at play using China as an example to explain on what enabled it to build a massive export led economy and position itself as world factory. Deeper analysis of these factors reveals that none of these advantages are sustainable in long run and eventually the equation will reverse in the favor of home countries. One of the most important factors was labor cost which was the biggest motivator for companies to shift their high labor content jobs to China. It is now evident that with wages beginning to ascend with CAGR of 16% to 18% in China, the gap is narrowing much faster than most companies anticipated initially. With a sharp decline expected in working age population and end of freely available migrant labor from rural areas demanding higher wages, this advantage is fast evaporating. Secondly, in past China had kept its currency undervalued to keep its exports competitive enabling it to become leader in exports share. We have found that post 2005, China can no longer keep its currency undervalued to the extent it did in past and Yuan will eventually appreciate to its equilibrium value, a movement which was long suppressed through Chinese Monetary and exchange rate policies. This movement will further erode the left over cost advantage. In addition to these critical factors, we found that other factors like subsidies for energy and low cost of capital and preferential incentives to protect key industries will no longer work in China’s favor. Contextual changes in the market like role of technology clusters, rising volatility in transportation costs and higher product variety are making companies realize that gaining back the flexibility and service performance that they lost in order to gain a temporary cost advantage will now be much more challenging. We conclude that China’s example has a great learning for corporate managers today who are now devising their global sourcing strategies & they need to develop a comprehensive strategy on keeping their manufacturing capabilities in their home country instead of now moving to a newer location. As a new LCCS location today, will bring them back to the same problem that they are facing with China today.