Hedging China Manufacturing Through India Just Became Corporate Strategy

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India and Vietnam are becoming increasingly attractive for manufacturing as China costs increase and workforces become aggressive

Op-Ed Commentary: Chris Devonshire-Ellis

Jun. 26 – The regrettable – and somewhat absurd – instance a few days ago of Chinese workers demanding to be fired in order to gain compensation payments has gained traction around the world. However, while the unofficial hostage taking of the American manager may be shocking, the underlying trend is not that of Chinese worker discontent. The underlying trend is what sparked the situation in the first place – the U.S. manufacturer uprooting part of its China plant and relocating it to Mumbai, India.

When I first ventured Dezan Shira & Associates out of China some seven years ago, I got not a little flack over it alongside accusations of stupidity. China was doing just fine, and order books were full. Yet, when making executive decisions concerning the firm’s development strategy, I have always kept an eye on the demographics. It was obvious at the time (Chinese officials even said so) that China’s worker demographic of young, inexpensive labor, was drawing to a close. While India’s infrastructure was, and still is, nowhere close to that of China’s, the country did possess the one thing that China was starting to run out of – an up-and-coming available young workforce.

When explaining my decision to invest outside of China and develop elsewhere in Asia, and specifically India, I made the observation that what we at Dezan Shira & Associates were really good at were three basic things:

  1. We weren’t afraid of huge countries (a lot of people are intimidated by China);
  2. We were used to dealing with emerging markets and evolving laws and regulations (dealing with that is where our expertise come in – and knowledge of dealing with it generates our fees); and
  3. We knew our way around countries with large and young work forces (HR and payroll issues are hugely important when dealing with labor forces that can run into the thousands, as some of our clients have).

Having had a look at several other markets – I studied North Korea and Mongolia – the answer seemed obvious. At the basic level, we wouldn’t be intimidated by India, although we would have a lot to learn. Consequently, we set up offices simultaneously in Delhi and Mumbai, registering Dezan Shira & Associates as a consultancy practice there. Back in China, people thought we were nuts.

That’s not to say I didn’t make mistakes. I did. One was to assume that after what was at the time 15 years in China, I’d seen all the scams and difficulties that could possibly happen. That was naïve, and I also got ripped off a couple of times and had dealings with avaricious lawyers and conmen when getting started. I should also have concentrated full time on India instead of commuting between India and China, which is what I did for five years. Had I done the former, certain obstacles and challenges would have been avoided.

India, then, is largely the same as China – you need management keeping a daily eye on it or things can go wrong. When the cat is away, the mice will play is as true in Mumbai as it is in Shanghai. But these are par for the course, and part of the learning cycle. Today, we now understand how to both operate and not operate a business there – always vital for the true professional consultants. It’s easy to pontificate from an office in Seattle or New York. The real professionals – and the valuable on-the-ground advice and experience that comes with them – are those that are physically based in Mumbai, Beijing and so on.

Meanwhile, in the years since we first set up shop in India, the hedging of China has become a reality. Wages have increased dramatically, and the Chinese government has upped the ante on social welfare payments (an aging population requires more money) and has begun cracking down on foreigners working in China (competing with locals for management positions in a shrinking workforce). Although we have had our ups and down there, India has been developing and passing laws and regulations in the meantime that make it increasingly friendly to foreign investment – just at a time when China has become less so. India still has a way to go before it becomes the investment darling of the world, but there are definable triggers that will make it so:

  1. Passing of the long debated Tax Reform Bill – which will reduce income tax by 30 percent overnight (possibly 2014)
  2. Electing a government that has at least some semblance of majority to pass through much needed economic reforms (elections are next year)

India’s low-cost labor dividend is already in place and in pure numbers it is already larger than China’s. Goldman Sachs states that India is adding 110 million workers to its labor pool by 2020 at a time when China will add just 10 percent of that in terms of total availability. There are other commercial factors that are pushing companies to hedge their China operations. Indian labor costs are about 30 percent of labor costs in China and, as the U.S. factory in Beijing will be well aware, the costs of laying off staff in India at present are just one month’s salary in lieu of notice. In China, it’s one month’s salary, plus another month’s salary for every year of service. Plus the welfare costs – not just the one month’s termination, but also for each month of severance.

India has its problems, but so did China when I first set up Dezan Shira & Associates over 20 years ago. Back then, China’s infrastructure wasn’t in place – the road to Beijing’s Capital Airport was just two lanes and had donkeys and carts on it. The only refreshments at the only terminal were dried noodles with hot water provided by a Russian Samovar and the only coffee available was in Nescafe sachets, topped up with water from the same Samovar. In Shanghai, the only places foreigners could shop were Friendship Stores, and it was illegal to possess RMB. Sparrows’ eggs were sold on sticks as a snack outside of the Peace Hotel, and the only nightclub was the doddery old Jazz Band in the same venue. Everything closed by 9pm. If anything, China back then was even more underdeveloped than India is today.

As I said at the beginning of the article, the trend is now for India to become the global manufacturer’s destination of choice. And as costs increase, even selling your product in China may not be a sufficient enough incentive to keep a factory and its operating costs in China. China’s own tax treaties with ASEAN just next door have done away with import duties between China and its neighbors, and with wages in Vietnam about 30 percent to 40 percent of those in Guangdong, factories have long been relocating.

The truth is out there, and it states that for many manufacturers, it makes better sense to put the factory in Vietnam or India, and then resell into the China market. Doing so avoids the hassle of Chinese militancy in the workforce, the high costs of wages, the high costs of social welfare, and the high costs of termination. Hedging China just became a fact, and the recent events at the American factory in Beijing prove one thing – the manufacturing investment trend is increasingly heading for India, Vietnam and the rest of emerging Asia. The corporate recognition of India as a serious competitor to China for establishing global manufacturing plants has just arrived as an acceptable and recognized multinational investment strategy.

Chris Devonshire-Ellis is the founding partner of Dezan Shira & Associates, starting the practice in China in 1992. Since then, the firm has grown to 12 China offices and is now also in India, Vietnam and Singapore. Chris ran the practice’s China operations from 1992–2009 and is now responsible for India and Singapore. He is based in Singapore.

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11 Responses

  • Nick Roerich says:

    Great article by Chris as always. I’d like to compare the demands of todays Chinese workers with that of the Russian workers after the 1917 revolution. They demanded a ten hour work day, “polite treatment” by their employers and two weeks notice before being let go. Todays Chinese workers are forgetting their proliterian roots and trying too fast too quickly to make demands on foreign employers. They should remember what the true Soviets settled for instead of all trying to buy second houses and BMW’s and become capitalists when they are intellectually working class with no real code of honor or sense of appreciation of the effort it takes to get them jobs in the first place. The Indians may well be more grateful.

  • Renaud says:

    If you can find productive workers in India or Vietnam, if you have all the components / raw materials in the same area as your factory, if you can find enough engineers, and if speed to market is acceptable, it might make sense to set up operations there.
    But let’s stop this constant mention of the difference in wages! It just assumes that workers are interchangeable. It is common for one factory to make 10 defect-free units per labor hour (for example), and for the factory next door (producing the same widget) to make only 5. The “cost of labor” is much lower in the former, simply because of higher productivity and quality.

  • @Renaud – the cost of labor is entirely relevant. This is a very basic average comparison:
    Chinese Worker: USD9,750 per annum
    Welfare Costs @USD3,500-4,900 per annum
    Total Average Mean Cost Per Annum, per worker: USD13,950.00
    Average rate of increase per annum: 18%

    Indian Worker: USD3,700 per annum
    Welfare Costs @405 per annum
    Total Average Cost Per Annum: USD4,105.00
    Average rate of increase per annum: 2%

    This means you can hire three Indian workers for the price of one Chinese worker, and the Chinese worker rate is also rising significantly faster. That gap will increase to 4 to 1 in three years. That’s not an insignificant labor discount. One should also factor in the cost of retrenchment:
    Chinese Worker: One months severance, one month for each year of service, plus welfare costs of each month.
    Indian Worker: One months severance.

    What you are actually alluding too is the higher productivity ratio of Chinese workers. This is true, you will get higher productivity in China than you will in India or Vietnam. The key to answering the production cost question therefore is the cost of labor factored against the productivity ratio. Let’s set the optimum productivity ratio at a value of USD1000 for a single workers profit margin in what he produces.

    In China that gives us a cost of USD13,950 for every USD1,000 profit
    In India, lets assume productivity is half of that in China at USD500 per worker.
    That gives us costs of USD4,605 for every USD500 profit.

    The danger for China is that even if Indian workers are 50% less productive, it still makes sense to manufacture there because overall it costs less. And the problem with that calculation is that Indian productivity is far higher than 50% of that in China, and the productivity ratio is rising. Whereas in China, you pretty much have reached the optimum productivity level but wages are still increasing.

    The general rule of thumb I see being deployed in India and Vietnam is that if factories there can get to 70% of the China productivity, it makes sense to relocate to these countries. Not all factories are there yet in either India or Vietnam. But there is only one way this equation is going to go – Indian, Vietnamese and South-East Asian factories will increase their productivity ratios – and China will continue to get more expensive.

    The writing is on the wall, and I can’t put it any clearer than that. Half of our clients in India and Vietnam are ex-China. You face competition and the Head Office bean counters will dictate where production is based, not the manufacturing or logistics engineers. They will go where they are told too.

    Best wishes
    Chris

  • @Nick Roerich: Thanks for your kind words. My job has always been about spotting trends – I came to China when it was considered a pariah state just after Tiananmen. No one wanted to go there. But I did, I knew it would recover and look what happened. The same is true of India and what is happening in South-East Asia and ASEAN. Follow the demographics, and you won’t go far wrong. China will be OK, just not as dynamic as before at 5% growth per annum. India will break loose and be doing 10% plus and I want part of that, and of what is happening in ASEAN. My role is to ensure our firm and publishing business continue to grow at the 20% mark in revenues and profits per annum I’ve achieved every year for the past 15 years, which is why I continue to do the job I do. Best regards – Chris

  • Don Croner says:

    Chris are you saying in effect that to maintain high sustainable growth rates in your business now is the time to look beyond China?

  • Renaud says:

    Chris,
    But I guess workers in Madagascar and in Ethiopia are cheaper than those in India/Vietnam? So, by your logic, India and Vietnam are not the best places for manufacturing?
    And, in a similar fashion, I guess China’s export numbers should have gone down as it’s wages went up?
    My point is, the level of wages is only one criterion among many others.
    For example, some electronic manufacturers settled down in Vietnam and had to go back to China. They noticed that they had to import most components from China (higher costs + lower speed to market), and that in the end labor is only a small part of their overall costs.
    Now I agree with you that, as the supply chain matures in India and Vietnam, and as they learn how to make more complex products (having complex jackets, for example, made in South-East Asia is not that easy), these countries will get more business coming from China.

  • @Don: Yes, I’m saying that growth will and is slowing in China. Also our firm has a wide capital base of income, so constantly getting another 20% increase every year after 15 years becomes more difficult. In order to continue that growth rate we need to be looking outside of China at other potentially fast growing markets and I think we have in India and ASEAN. Our practices in Singapore, India and Vietnam are growing faster than our practice in China, although that said, we still expect to be opening up a new office in Chengdu later this autumn.

    @Renaud: Well Madagascar and Ethiopia have their own dynamics, although I can see you’re being facetious. In fact, Africa is starting to attract industry away from Asia, and you’ll see some textiles and garments manufacturing move to places such as Kenya and Tanzania over the next decade. Nairobi is only a five hour flight from Mumbai and Dezan Shira are keeping an eye on East African developments in fact.

    In terms of Vietnam, as part of ASEAN it has an FTA with China. We have listed online all the tax treaties China has with ASEAN on our ASEAN Briefing website here:
    http://www.aseanbriefing.com/regions/asean.html
    so if your product falls under the treaty, there’s no import duty. The relocation of factories and the types of product needs to be matched with the tax treaty status; if the product comes under the treaty then no import/export duties are payable and it makes sense to consider relocation. If not, then you have to factor that cost in and do the math on applicable export rebates and so on – which is a lot of the trade work Dezan Shira does – make a business case for clients, and work out the most financially effective place to manufacture. It’s not just about wages, you’re correct, but thats an important part of the production cost, along with land use, tax treaty benefits and so on.

    Meanwhile, half of the clients we attract in India are ex-China. The others are new investors wanting to go to India rather than China because of the cost element, or they want to sell to the India market. There are market sectors in India than are open to foreign investment that are closed in China for example. See: http://www.india-briefing.com/news/obamas-proposed-u-s-trade-representative-demonstrates-economic-shift-towards-india-6290.html/

    Thanks Guys for your comments – Chris

  • Renaud says:

    Chris,
    I see. For companies that want to sell into China, I understand that producing in an ASEAN country can make more sense than producing in China.
    Another element we forgot to mention is the AQSIQ procedures when goods are imported into China – sometimes it takes entire month, and they have the highest standards of the world. That’s another reason why making in China for China still makes sense for some companies.

  • @Renaud – Indeed – and it took China a long time to get there. China manufacturing used to be rubbish (and in many instances still is). India and ASEAN nations will also have to go through the same development curve. Many Indian manufacturers have the requisite quality standards already, but many still have to catch up. Like always, due diligence on the QC aspect of sourcing – anywhere – is a pre-requisite of successful trading. – Chris

  • Sudendra Rao says:

    Chris – very insightful and a great article. China has come a long way with its quality of products. India has a lot to catch up with but worth the efforts particularly considering the cost advantage, political and labor challenges. – Sudendra Rao

  • Thanks Sedendra – India is a work in progress but once the productivity starts to get to about 70% of China’s, that seems to be the general trigger point for relocating or shifting manufacturing. – Chris

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