Saturday, March 24, 2012
Rising Chinese wages a headache for US firms
First came anger, then depression and then acceptance.
In the three decades since Deng Xiaoping began opening China's economy, US manufacturers have gone through something resembling Elisabeth Kuebler-Ross's five stages of grief.
Industry cried foul, then groped around for solutions, before accepting the rules of the game had changed - deciding to make a buck by offshoring some of their own production to China.
To be sure, there are still frequent spasms of anger over China's ability to produce goods at "unfair" prices, notably in election years.
But the bitter pain of jobs lost and factories closed has been sweetened just slightly over the years.
Using cheap Chinese labourers has resulted in $499 iPads, bumper corporate profits and -- in turn -- fatter pensions for those who have stock-based plans.
But there are already signs that this low-cost, high-reward Chinese paradigm is coming to an end.
Late on Thursday, US footwear giant Nike reported it had made even more profit than it did the quarter before, yet its stock sank.
Investors hacked about $1 billion off the company's value on Friday because of a reference to "declining gross margin" stashed in the bowels of the firm's quarterly report.
The details are complicated, but Nike's jargon in part referred to rising wages in places like China taking a chunk out of profits.
Indeed, the details show rising wages -- along with some other factors like higher material costs -- caused Nike's margins to fall two per cent in just one year.
That spells extra costs worth tens - if not hundreds - of millions of dollars.
But it is far from enough to make Nike's business unviable, so why the worry?
According to Sara Hasan, an analyst who follows Nike for investment firm McAdams Wright Ragen, the concern is that wages in China are only going to increase from here on in.
"It's a very big deal, and it's a longer-term issue definitely," she said.
In the last year, wages in China's southern industrial belt have risen 10 per cent, according to a report by Standard Chartered. They rose 11 per cent the year before that.
The Shanghai authorities recently announced the minimum wage will rise 13 per cent, doubtless prompted by labour shortages and worker unrest.
"As (China's) economy grows and as the middle class grows, I think the pressure is going to continue," said Ms Hasan.
Nike itself admits the costs are unlikely to fall any time soon: "While some raw material costs are starting to ease, we have not seen them retreat to their previous levels; for other input costs such as labour, upward pressure continues," CEO Parker told investors.
That leaves US manufacturers with only a handful of options: accept lower profits, pass the cost on to consumers or lower labour costs some other way.
Part of the answer for Lacrosse, a small Wisconsin-based footwear firm, was to shift some production from China to Vietnam, where wages are still relatively low.
"As costs in China have grown... we make a growing amount of our product in Vietnam," said Michael Newman, who deals with investor relations for the company.
Western China, Thailand, Malaysia and Indonesia are also cited as possible alternate production locations.
That has the added benefit of diversifying the supply base, but moves production away from China's lucrative domestic market.
For bigger firms, the answer may be to trim supply chains or tap consumers.
According to Ms Hasan, Nike is in a good position to leverage its brand strength and pass prices on to US and other consumers.
In the longer term, Nike also hopes to cut production costs the old-fashioned way, through increased automation.
The company has invested its hopes in FlyKnit technology, which knits a shoe upper in one go, reducing the need for workers to assemble dozens of pieces.
Consulting firm Accenture believes that through a mix of these responses, manufacturers with a large footprint in China can handle wage increases of as much as 30 per cent without too much trouble.
"However," its report published earlier this year noted, "China's low-labour cost advantage will not last forever."
That will undoubtedly change the rules of the game for US manufacturers once again.