China’s changing (textile) manufacturing landscape
China has been renowned during the past decade, as basically a site for manufactured goods, especially for textiles and clothing. The main factors were low wages, a practically unlimited work force and strong growth of the economy. But, as we all know, things are changing dramatically.
This implies new challenges and requires new competitive priorities on part of sourcing and approach for Western companies. Textile-Future will therefore start to report on these changes and what this means for the future of foreign companies and sourcing in China. We take China as an example, but we will also enlighten other aspects of changes in manufacturing processes, thus we intend to bring all aspects to light and there will be several TextileFuture Newsletters tackling these aspects, from all angles
This Newsletter will elaborate on the changes of China’s manufacturing landscape and the findings are based upon a just released study and surveys of McKinsey Quarterly of McKinsey Company (international consultancy), and the authors Karel Eloot, Alan Hung, and Martin Lehnich.
To start, we dig into the astonishing development of China as a powerhouse since the 1980s, when China took ranking seven, trailing Italy. In 2011, as we all are aware, China not only overtook the United States to become the world’s largest producer of manufactured goods, but also used its huge manufacturing engine to boost living standards by doubling the country’s GDP per capita over the last decade. Please remember well, that the industrialisation of the United Kingdom took 150 years in comparison.
We all know that China faces new challenges such as economic growth slowing, higher wages and other factor costs rise, value chains become more complex, and consumers grow more sophisticated and demanding. These pressures are rising against the backdrop of a more fundamental macroeconomic reality: the almost inevitable decline in the relative role of manufacturing as China becomes richer. Manufacturing growth is slowing more quickly than aggregate economic growth, for example, and evidence suggest that the country is already losing some new factory investments to lower cost locations, such as Vietnam, sparking concern about China’s manufacturing competiveness.
Competitiveness is a broad term that can confuse more than clarify. During the 1980s, for example, there was much hand-wringing in The U.S. about declining manufacturing competitiveness versus Japan, it was affecting investment goods, automotives and electronics, and in the later part also the manufacturing of textiles and clothing and textile machinery in America. The focus then switched on the failings of “Japan Inc.”. The take-up of in the American manufacturing came along with the production of SUV and the boom in US high tech manufacturing. In the U.S. at that time, as in China of today, there isn’t just one manufacturing sector; there are many, each with different competitive strengths and weaknesses.
In order to get a balanced view on the actual developments, we point at four key challenges affecting different types of manufacturers in different ways resulting in the formulation of competitive priorities whose importance again varies for players of different segments of the economy and manufacturing world. Despite the variation across manufacturing subsectors, companies – Chinese owned and multinational alike, cannot escape the need to raise their game and move up the value chain by boosting productivity, refining product development approaches, and taming supply chain complexity. These will also be of imminent influence on the manufacture of textiles and clothing, as well as on textile machinery. Those companies doing their homework actually, will prosper in the years ahead, while those relying on yesterday’s model of rock bottom wages and stratospheric domestic growth rates are likely to fade away.
Actual and future challenges
For years, China’s success was based on low salaries and a strong supply base, along with high investment in infrastructure such as ports, roads and rail, accompanied by solid engineering and technical skills that provided a strong platform for manufacturing exports. Meanwhile, a vast domestic market helped to fuel China’s continuing transition into a consumption based economy. Today, the outlook is more mixed and complex.
The McKinsey Global Institute has established a set of manufacturing archetypes can be had from Table 1
|The McKinsey Institute’s Grouping of China’s Manufacturers|
|Type / Additional comment||Sectors||Success Factors|
|Global Producers for domestic market, representing around one third share of both Chinese and global 2010 manufacturing value added||Appliances, automotive and transport equipment, chemicals electrical machinery and pharmaceuticals||Global R&D, ability to generate stream of new products and models|
|Energy and resource intensive commodity players, representing around a quarter of Chinese and 22 % of global 2010 manufacturing value added||Metals and mining, pulp and paper, other extractive industries||Privileged access to raw materials and energy, high resource and energy productivity, transportation and infrastructure logistics, proximity to demand|
|Global technologies / global innovators, representing 9 % of both Chinese and global 2010 manufcturing value added||Consumer electronics, office machinery, semiconductors, telecommunication equipment, as well as medical, optical and other precision equipment||Strong global R&D and production networks, high value density of products, economically transportable from production sites to customers around the globe|
|Regional Processing, representing around one fifth of Chinese and 28 % of global 2010 manufacturing value added||Fabricated metals, food and beverages, printing, and tobacco||Close observation of customers and competitors to develop deep insights|
|Labour intensive tradables, representing 10 % of Chinese and 7 % of global 2010 manufacturing value added||Apparel, textiles, and other handcrafts||Low cost production critical|
|Source: McKinsey Global Institute June 2013 / TextileFuture July 2013 All rights reserved!|
Rising wages, and the appreciation of the Chinese currency have dampened China’s exports in recent years – on top of the financial crisis and the slowdown of the world economy – and focused global attention on China’s future viability as a low cost manufacturing centre. Most multinationals producing labour intensive goods, like textiles and apparel, are actively seeking to diversify beyond China to reduce costs and mitigate political and supply chain risks. In this context we would like to draw your attention to the diversification in sourcing of apparel, the manufacturing of textiles and of textile machinery. These companies establishing hubs in the large Asian markets always bring forward that they need to reduce cost, while guaranteeing the high quality of their products and to bring activities closer to the customers. Since this reflects a regional focus, this is less a global competitive issue but more a question of which players in the value chain will create the most value.
McKinsey Research estimates that by 2020, the income of more than half of China’s urban households, calculated on purchasing power parity basis, will catapult them into the upper middle class. It is noteworthy that in 2000 this category barely existed in China. The members of this group already demand innovative products that require engineering and manufacturing capabilities, and many domestic producers do not yet adequately possess the necessary means of manufacture. As an example, McKinsey lists a Chinese television panel maker, who confessed that his company cannot fully meet the requirements of high end customers, and that the quality of his company’s flat screen panels is exceeded by products from fast moving South Korean competitors. The same challenge face also China’s automakers because consumers perceive their brands as lower in quality, even compared to foreign brands assembled in nearby Chinese factories. These issues are true for other sectors, such as appliances, chemicals, electrical and office machinery, pharmaceuticals, telecommunication, and transportation equipment. They all have one thing in common: the strength of their R&D technology, and the ability to bring customers a steady stream of new products and services. Rising Chinese consumer expectations will require even food and beverage players to raise freshness and regulatory compliance, and there, China’s standards still lag behind Western ones. But, as we know, China’s government is pushing ahead also in these areas.
The rising value chain complexity
A big challenge is the coping with the rising value chain complexity that accompanies consumer growth. Greater affluence and rapid urbanisation require product makers to manage, make, and deliver an array of increasingly diverse and customised products to increasingly remote locations. As TextileFuture’s readers, you are aware that logistics in China do lack the necessary power to cope with this factor. McKinsey projects that between now and 2015, almost two thirds of the growth in demand for fast moving consumer goods will come from smaller (Tier 3 and Tier 4) cities in China, TextileFuture has already covered these issues before and has been pointing to the fact that they will supersede Tier 1 cities, such as Beijing or Shanghai, and by a factor of 20. We recall also that many of the world famous fashion and luxury chains are investing in new stores in such “secondary” Chinese areas.
Product proliferation and booming e-commerce do contribute to value chain complexity. B2C online sales in China are expected to grow 45 % annually from 2010 to 2015. For product makers, this means smaller and smaller lot sizes and deliveries to households farther and farther “out there”. During Chinese festival periods, the supply chains of many companies already creak under the strain of online orders. Demanding consumers add to supply chain headaches. Since many retailers in China accept cash-on-delivery payments, it is not uncommon for shoppers to pit online retailers against one another by ordering, say, three identical products from three retailers, and refusing delivery to all, but the first to arrive! TextileFuture has published insights in the online market before where all of these phenomena were touched.
The market volatility makes planning difficult for China’s manufacturers. This is very problematic for companies that routinely make large, long lived capital expenditures, and these returns are crucial determinants of performance. This is certainly also true for textile manufacturers when they have to decide on state-of-the-art textile machinery. On the other hand the same is true for textile machinery manufacturers. The demand for a higher degree of automation is another decisive factor, as we are aware of the fact that it becomes very difficult to find qualified and skilled labour in China, particularly in the textile relevant sectors.
New cycles ahead
The rising labour costs in China and slowing growth dampen the ability of China’s steadily rising industrial output to deliver (necessary) regular productivity gains, thus manufacturers will need to strive for global levels of operational excellence. Energy efficiency is an opportunity for many companies – also in the textile and clothing sector – but by far it represents not the only one. Companies hoping to differentiate themselves beyond low cost labour will also f0ocus on their efforts upstream to harness innovation and product development, or downstream to tame supply chain complexity, or both, depending on the characteristics of competition in their sectors.
Plant managers in domestic and multinational companies alike have worked hard to bring manufacturing excellence tools and approaches to the Chinese shop floors, but a significant potential remains, because plant managers in China often focus on “hard” technical tools at the expense of “softer” ones involving mind-sets and behaviour. For instance, a recent lean manufacturing transformation at a state owned enterprise fell far short of its efficiency targets when managers and supervisors failed to complement the otherwise excellent technical changes with the necessary softer skills, including leadership that would have made the changes successful and sticking.
Another problem is the fact that many workers are relatively new to the job, such as frontline managers, lacking the experience to identify the problems inevitably associated with new plants, equipment and new ventures. They merely react to problems rather than to look for their root causes. Of course this leaves enough space for instance for traditional textile machinery manufacturers to offer more specific training and to manage key projects up to implementation and beyond. These projects however might polish-up the figures of the supplier, however only medium term, because of the gains in knowhow of their customers and domestic competitors.
Another important factor, cultural differences thwart operation improvements in Chinese companies. As an example serves an auto plant (multinational joint venture) where the
Western partner installed visual performance boards to make the status of work projects transparent with the intent that the tools would be accepted as everywhere else, but the frontline workers resisted them, interpreting the initiative as a criticism of individual colleagues, forcing the joint venture’s leaders to devise ways to achieve the same effect without alienating the staff. Also senior plant managers, while supporting the changes, were initially uncomfortable about role-.modelling the more transparent and inclusive way of working. A new continuous improvement department eventually helped workers and managers alike to view greater transparency and continuous improvement as a new way of working rather than a “flavour of the month” exercise. Such events are not uncommon, and the fact that domestic leaders become involved is rare, all too often, the front line must sort out such changes itself. In this context such incidents do also affect efficiency and productivity.
For Chinese companies there has to be also a new approach to R&D than before, it is far beyond the “faster, cheaper” fixation. McKinsey sees upcoming Chinese innovators, but also dozens of smaller players struggling to develop R&D pipelines to help them grow from scrappy upstarts into incumbents realising their global ambitions. It has to be added that the copying mind-set still remains strong!
Also to some extent, multinationals face a mind-set challenge, many invest significantly in their China R&D units while continuing to regard them as cost saving satellites of the home office “mother ship”. Even when such companies establish supposedly autonomous R&D units in China, many lack the support and skills to become intellectual property creators, nut just consumers.
The complexity of the value chain
Long cycles, characterised by so-so levels of transparency, and cross functional collaboration are proving insufficient, companies will have to start by revisiting their demand planning. Poor or delayed forecast can disrupt operations and leading to excess inventories, while also upsetting customers downstream. A company developed a streamlined “good enough” planning approach, for the high end goods it crafted specific plans by product line. It resulted in overall improvement in forecast accuracy to more than 65 %, from 35 %. Inventory fell from more than 55 days to 30 days, and an increase of its proportion of on-time deliveries to more than 95 %, from 60 %. In addition, the changes in the company’s planning approach made the work more interesting for its employees, as many of them subsequently received training in advanced forecasting techniques. Consequently, employee turnover among planning teams decreased dramatically from 50 % to just 20 %. In the second phase, the company will extend this approach for high end products to others with similar demand characteristics. In conclusion, the company has been separating a monolithic China supply chain into nimbler “splinters” that can better manage complexity. Products with steadier demand go to market in the traditional manner (costal distribution centres, large drop-ship orders to retail partners). Higher end products travel via smaller regional distribution centres located closer to demand inland. For some products, this approach allows the company to experiment with postponement strategies, finalising product assembly closer to demand – this helps to reduce costs and inventory levels, in the case of some customers by as much as 45 %.
As companies look to move their footprints closer to customers in Tier 3 and Tier 4 cities in China’s interior, another change will be the long term development of logistics hubs and assets. These investments are risky, and many senior executives are worried about overextending their companies, and some say that it is a need to “go West – but not too far West”. Domestic Chinese companies with global plans know that getting closer to customers means Western customers as well.
McKinsey’s authors conclude their study with the following statement: “For Chinese owned and multinational manufacturers alike, the imperatives now are to boost productivity, refine product development approaches, and tame supply chain complexity. The ones following this road create an enduring competitive edge”.
TextileFuture wishes to add that once again, textile machinery, textile and clothing manufacture are at the forefront of these developments. The only pity is, that other industrial sectors do not consider textile relevant sectors serving as models for the revamping of their own sector. The prophet in its own country is never supported!