For years, labor rates have been the primary advantage Chinese manufacturers have benefited from, however, wage rates in China are growing at an accelerated rate, with some reports indicating they will surpass rates in Mexico and other developing countries very soon. What does this mean for your supply chain? Should you be concerned? A recording of this presentation can be viewed here: http://www.slideshare.net/ihs_supplychain/when-will-china-lose-its-lowcost-edge

1. Has China Lost Its
Low-Cost Edge?
Laura Hodges
Director, Pricing and Purchasing Service
September 27, 2012

2. Why the Concern about China?
• Recent studies have suggested that China has or will lose its low-cost
status over the next 3 years
• Buyers report that Chinese quality has just reached their comfort level
• Should you be concerned?
• Labor costs are exploding but remain low and productivity is high
• The renminbi will continue to appreciate over the long-term
• No cost advantage for most material prices
• Shipping costs are at extremely low levels
• How should this impact your sourcing decisions?
• Are there other countries that you should consider?
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3. China’s Rising Profile in US Trade
Share of U.S. Nominal Merchandise Imports, By Country, %
20
18
16
14
12
10
8
6
4
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
China Canada Mexico Japan
Source: IMF Direction of Trade Statistics.
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4. China Also Plays A Larger Role In Supply Chains
China as a Percentage of Global Production
0.60
0.55
0.50
0.45
0.40
0.35
0.30
0.25
0.20
0.15
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Base Metals* Steel Cement
*consumption
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5. The Chinese Economy Takes Over the Top Spot
Share of world GDP, measured in nominal US dollars
2010 2020
Other Asia, Other Asia, Mideast,
Pacific Mideast,
Africa Pacific Africa
20.5% 33.8% 6.1%
5.8%
Japan
8.7% North
Emerging North America
Europe America 20.1%
Japan
6.4% 27.1% 5.7%
Other
Western Other Emerging Americas
Western 7.1%
Europe Americas Europe Europe
25.2% 6.3% 7.5% 19.6%
US 22.9% US 16.9%
China 9.4% China 19.6%
India 2.7% India 5.5%
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6. Yet, Overall Labor Costs Are Still Very Low
• The average Chinese manufacturing worker earns approximately
$2.50 per hour
• This reflects a more than 12.5% annual growth over the past decade
• Strong upward pressures on wages
• Minimum wages are rising by more than 20% annually in some provinces
• Inflation rising with higher food and energy costs
• Productivity gains pushed 10% higher annually
• However wide disparity exists across the country and occupation
• Over the next decade, wages are expected to double and will grow
another 10-15% in the next 3-5 years
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7. No Chinese Advantage on Material Costs
Global Cold-Rolled Sheet Prices Global Copper Prices
(USD per metric ton) (US$ per metric ton)
1,400 12,000
1,200
10,000
1,000
8,000
800
6,000
600
400 4,000
200 2,000
0 0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US Europe China US Europe China
Global Ethylene Prices Global Polypropylene Prices
(US$ per metric ton) (US$ per metric ton)
2,000 2,800
2,600
1,800
2,400
1,600 2,200
1,400 2,000
1,800
1,200 1,600
1,000 1,400
1,200
800
1,000
600 800
400 600
400
200 200
0 0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
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US Europe Southeast Asia US Europe Northeast Asia
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8. Continued RMB Appreciation
Canadian Dollar Euro
(Canadian dollars per US dollar, quarterly averages) (Euro per US dollar, quarterly averages)
Japanese Yen Chinese Renminbi
(Yen per US dollar, quarterly averages) (Yuan per US dollar, quarterly averages)
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9. Shipping Rates Are Not A Concern
(Baltic Dry Index, 1985=1000)
12,000
Abundant supply should
keep rates low for at least
10,000
the next three years
8,000
6,000
4,000
2,000
0
2003M1 2005M1 2007M1 2009M1 2011M1
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10. Productivity Gains Have Been Strong
(Chinese output per employee, USD)
50,000
40,000
30,000
20,000
10,000
2005 2006 2007 2008 2009 2010 2011
Productivity has almost doubled since 2005,
reducing the true impact of higher wages
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11. How Does this Impact China’s Cost Advantage?
US Production Costs for Steel Castings Chinese Production Costs for Steel Castings
(Source: 2010 Annual Survey of Manufacturers) (Source: 2010 Annual Survey of Manufacturers)
Cost ('000s) Share Cost ('000s) Share
Payroll 5,412,793 30.42% Payroll 1,353,198 9.85%
Production 3,880,981 21.81% Production 970,245 7.06%
Management 1,531,812 8.61% Management 382,953 2.79%
Energy 1,499,672 8.43% Energy 1,499,672 10.92%
Material 10,881,765 61.15% Material 10,881,765 79.23%
Scrap 5,651,202 31.76% Scrap 5,651,202 41.15%
Ferrous shapes & forms 2,560,415 14.39% Ferrous shapes & forms 2,560,415 18.64%
Sand 512,083 2.88% Sand 512,083 3.73%
Industrial equipment 292,619 1.64% Industrial equipment 292,619 2.13%
Nonmetallic products 292,619 1.64% Nonmetallic products 292,619 2.13%
Nonferrous shapes & forms 329,196 1.85% Nonferrous shapes & forms 329,196 2.40%
Other 1,261,919 7.09% Other 1,261,919 9.19%
Production Costs 17,794,230 100.00% Production Costs 13,734,635 100.00%
Value of Shipments 27,100,175 65.66%
Assume material costs are roughly equal
The average Chinese manufacturing worker is only 40% as productive as the same US worker
The average Chinese manufacturing wage is only 10% of the US wage
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The Chinese cost advantage is 23% in 2010
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12. Cost Erosion Continues In the Next Decade
Existing 23% Cost
(Cost Index, Steel Castings, 2010Q1=100) Advantage
170.0 Eliminated by End
of Decade
160.0
150.0
140.0
130.0
120.0
110.0
100.0
2010Q1 2012Q1 2014Q1 2016Q1 2018Q1 2020Q1 2022Q1
US China
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13. Cost Saving Still Exists But For How Long?
• Using this example, casting production costs in China are
approximately 23% lower than those in the US
• Shipping costs, exchange rate appreciation, and supply chain
risks do cut into these savings
• While it may still make sense to source from China, the
margins are narrowing
• Over the next decade, Chinese wages are expected to move
from 10% of US wages to 25%
• This is enough to make China uncompetitive for your basic
manufactured goods
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14. Lower-Cost Countries Are Also Available
Global Manufacturing Wages (USD per hour, 2012)
Pakistan
Vietnam
Indonesia
Philippines
Thailand Depending upon your
India location, Indonesia, and
Peru
China Mexico may be good
Turkey alternative sourcing options
Venezuela
Romania
Mexico
Malaysia
Hungary
Brazil
South Africa
Taiw an
Czech
Portugal
Argentina
Korea, South
United
United States
Japan
Canada
Germany
Australia
Sw itzerland
Norw ay
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0.00 10.00 20.00 30.00 40.00 50.00
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15. Indonesia Offers an Attractive Option
(Manufacturing wage, USD per hour)
8.00
6.00
4.00
2.00
0.00
2000 2005 2010 2015 2020
Mexico China Indonesia
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16. No Country is Without Risks
Mexico - Exporter Risk Rating - 10 (1-Year) / 23 (5-Year)
- A cumbersome bureaucracy and endemic corruption persists
- Increased violence from drug gangs and a clampdown on organised crime
- A labour surplus exists but shortage of technically skilled workers is a problem
- Renewed efforts to make labour laws more flexible but political resistance is strong
Indonesia - Exporter Risk Rating - 11 (1-Year) / 34 (5-Year)
- Endemic corruption, inefficient bureaucracy, and red tape are a challenge
- Reform on business regulations has slowed markedly over the last few years
- A 40-hour limit on the working week is comparative disadvantage
- Indonesia's labour force is under-educated
The Risk Scores represent a subjective probability of a range of business risks in a given
country, and the numbers range from 0 to 100, with lower numbers representing lower risk
The China risk score is currently 14 (1-Year) and 33 (5-Year)
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17. Implications for Buyers
• China will retain its low-cost status over the next five years …
• … depending upon the labor intensity of the manufacturing process
• Labor was the primary advantage in China
• And those costs are rising along with the exchange rate
• Expect a pause this year for exchange rates but wages will grow near 10%
• But China is approaching the end of its low-cost status
• For high-labor, low-margin goods, start looking for alternative low-
cost countries (Indonesia) or ones closer to home (Mexico)
• Be aware of the unique risks in each country
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18. Thank you!
Contact IHS today to learn more…
Americas
Marc Venditti
+1 781 301-9325
Asia/Pacific
Christopher Munch-Fals
+65 6576 5354
Europe, Middle East & Africa
Natalie Rowlands
+44 203 159 3260
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