Are “China prices” becoming yesterday’s trade story?
Manufacturers on the Chinese mainland are under immense pressure to stay profitable, while maintaining their export price competitiveness. That’s down to rising costs and the appreciation of the Rmb.
Since the Rmb regime changed in 2005, the currency has appreciated 23% against the US dollar as at the end of September.
In tandem, wages have been rising rapidly since 2009. After 30 provinces and municipal cities increased minimum wage levels by an average of 22.8% in 2010, this year 18 provinces and municipal cities have since raised minimum wages again by some 20%.
China’s export price index began its rise in May last year. Higher export prices can be a palliative to manufacturers unable to absorb all cost increases for a sustained period. But given the intense competition in the globalised production environment, even a small shift in cost conditions can lead to changes in China’s competitive position.
Changing competitive positions of lower value-added and labour intensive products – such as garments and footwear – are imminent. With textile quota no longer an issue, US and EU importers now pay more attention to price and tariff savings.
As a result, developing countries which still enjoy generalised system of preferences (GSP) status, such as Bangladesh and Cambodia, have become more popular sourcing markets for garments.
For other products with low profit margins, importers are also likely to shift their sourcing to alternative, low-cost countries; China is no longer a beneficiary of the US GSP and excluded from a large number of products under the EU GSP.
As from 2011, China’s share of garments and footwear exports to both the US and EU markets have decreased, while those of Vietnam, Bangladesh and Cambodia have risen.
It’s reasonable to ask whether this is the beginning of the end of the “China price” story. The country is graduating out of the labour intensive manufacturing industries that once outperformed all other competitors with its low production costs.
Productivity growth enhance China’s competitiveness
According to estimates by the World Bank, the growth in China’s manufacturing wages has more than been outpaced by labour productivity growth during the mid-1990s to mid-2000s. Consequently, China’s unit labour cost, which measures wage costs per unit of production, declined by close to 40% cumulatively during the 1995 to 2004 period, before bottoming out from 2005 onwards.
Between 2005 and 2010, average annual growth of labour productivity of China’s manufacturing industry slowed to 8.9%. But a more rapid rate of increase in wage level has led to a rise in unit labour costs.
For the low value-added processing trades, it’s become more difficult for labour productivity growth to catch up with wage growth and Rmb appreciation, hence leaving room for lower-wage countries to take over China’s turf.
However, it’s noteworthy that changes in China’s unit labour cost are not the same across different industries or industry segments.
The unit labour cost is not a comprehensive measure of competitiveness. Efficiency in such factors as the supply chain and product safety provides crucial factors for cross-country comparisons of competitiveness.
Despite rising unit labour cost and RMB appreciation, China’s share of manufactured exports in world trade continued to increase after 2005 and the country became the largest exporter in the world in 2009.
China has not only proved itself a leading production base of labour intensive products such as clothes, shoes and toys, but also a competitive exporter of high value-added electronic products.
China’s export performance suggests that it still enjoys competitive advantages for labour-intensive manufacturing and it captures higher value-added work as well.
Structural change
A feature of China’s export model is the evolving change in product mix. In the 1990s textiles, clothing and footwear used to represent a 40% share of China’s total exports. Since 2000, as a result of capital investment and faster growth in productivity, electronics has emerged as a new source of growth.
Similarly, other higher value-added industries such as machinery, transport equipment have grown faster than the traditional labour intensive industries.
China’s electronics production doubled in value terms between 2004 and 2008 amid continued relocation of manufacturing processes from advanced countries.
As a result, China’s share in world electronics production grew from 16.2% in 2004 to 25.7% in 2008.
China as a global relocation destination for electronics producers relies on its versatility. This includes its huge, inexpensive manual and technical labour force, competitive industry cluster and reliable supply chain.
That has made China the most competitive location for undertaking manufacturing processes for many IT, telecom and consumer electronics products.
China’s electronics industry enjoys not only economies of scale, but also economies of scope due to well developed industry clusters where upstream supplies include a wide range of parts and components, and ancillary items such as metals, plastics and electrical and packaging items which can be sourced locally and easily.
Also, essential support services such as freight forwarding and lab testing are all well developed, enabling manufacturers and exporters to enhance their efficiency and productivity.
Along with the development of increasingly sophisticated electronics products and specialisation in the global supply chain, China’s electronics industry has moved up the production value chain to assemble more sophisticated and advanced products like mobile phones, notebooks and tablet computers. Electronics manufacturers are also taking up more manufacturing and assembly works of parts and components such as semiconductors.
All of this is evident in the rising share of computer and telecom equipment in China’s total electronics exports from 2000 through 2010, while the share of consumer electronics, mainly consisting of audio-visual products such as TV sets and sound/video players, has fallen away.
It is noteworthy that though clothing as a share of China’s exports dropped from 13% in 2000 to 7.7% in 2010, the absolute export value increased from US$32.3 billion to US$121.1 billion.
This reflects the fact that China’s manufacturers have continued to apply technology to increase their productivity, resulting in improved vertical integration of the textile and garment industry in terms of elements such as raw material supplies, R&D and human resources training.
As pointed out by one garment merchandiser in Hong Kong, sourcing from the Asian region now targets Southeast Asian countries which can offer lower costs when supplying simple items in bulk orders; however, when looking for fashion items with sophisticated design, requiring higher skill levels and delivery in smaller batches with quick turnaround times, China is still the choice.
Innovation and upgrading
Michael Porter said in his study The Competitive Advantage of Nations that the only meaningful concept of competitiveness at the national level is productivity. As productivity is defined as the value of output produced by a unit of labour or capital, it would depend on the efficiency of production and the price the products can command.
In the case of China, productivity growth of low value-added products through short production chains may have declined, but for industries and industry segments that place stronger emphasis on items like efficient supply chain management, quality assurance and features enhancement, the country’s competitive advantage remains high, as evident in the still healthy growth of exports.
So, the ability to innovate and upgrade determine productivity growth, helping to contain unit labour cost increases and RMB appreciation in the long run.
In the years ahead under 12th Five Year Programme, China’s economic growth is expected to be driven more by domestic demand, particularly private consumption, and the Chinese government are set to support export processing trade manufacturers to expand their sales in the China domestic market.
China’s growing middle class market is expected to further enhance the economies of scale for domestic production, at the same creating an environment conducive for China’s manufacturers to invest in new technology and product innovation.
Selling Your Business
Q: I'm reaching retirement age and will likely be selling my business within the next five years. What are some of the things I can do to prepare my business for sale?
A: The completion of a sale can take over a year, so keep that in mind as you plan your exit strategy. Here are several basic steps you should take to ensure that your business is ready:
1. Get a business valuation. One of the first things you should do is obtain a realistic idea of what your business is worth from an objective, outside source. A professional valuation will give you a basis for gauging buyer offers and will give you an idea of what you can expect to net from the sale. It will also tell you your business's market position, financial situation, strengths and weaknesses (which you can hopefully correct prior to putting it on the market).
Valuations can be obtained from a number of sources, ranging from local accounting firms to regional business brokers and investment banking firms. As a rule, you should make sure the company performing your valuation has access to the most current national data regarding privately held transactions in your industry. Experience in selling firms of your type is obviously helpful as well.
2. Get your books in order. Buyers evaluating your business generally require at least three years' worth of financial information. The more formal your statements (accountant-reviewed or -prepared vs. internally generated statements), the better the impression you'll make-and the easier the due diligence for a buyer. Tax returns may suffice.
3. Understand the true profitability of your business. Most privately held businesses claim a variety of nonoperational expenses. Make sure you have supporting documentation for these expenses. For example, your business may be paying for your personal automobile lease.
In addition, there may be infrequent expenses you have incurred during the past three years that should be excluded in a buyer's analysis of recurring cash flow. There may be moving expenses if you've moved to a larger facility or unusual legal expenses.
4. Consult your financial advisor. It's wise to speak to your tax advisor for help planning your financial future. Understanding your personal and corporate tax situation may also help you recognize your options with regard to deal structure.
5. Make a good first impression. Will a buyer visiting your shop for the first time see order or chaos? Buyers look for companies that show well, as an orderly shop is often indicative of an orderly management team and back-room operations.
6. Organize your legal paperwork. Review your incorporation papers, permits, licensing agreements, leases, customer and vendor contracts, etc. Make sure you have them readily available, current and in order.
7. Consider management succession. If you're absolutely vital to your business, who will a buyer be able to turn to for help running the business after you leave? You should have a succession plan in place before going to market.
8. Know your reason for selling. Buyers are always curious as to why a seller wants to exit a business. (If it's so great, why are you leaving?) Be prepared to articulate your reasons.
9. Get your advisory team in place. Start interviewing attorneys and accountants who are proficient in mergers and acquisitions. Strongly consider hiring an intermediary, either a business broker or an investment banker, to represent you and help you through the selling process.
10. Keep your eye on the ball. Don't let your business performance decline because you're too focused on the sale of your business. This will only give buyers additional negotiating power to lower their offers.
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