IHS Has China Lost Its Low Cost Edge

Has China Lost its
Low-Cost Edge?
Laura Hodges
Director, Pricing and Purchasing Service
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?
Copyright 2013 IHS Inc. All Rights Reserved.
www.ihs.com/PricingPurchasing
Chinas 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.
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
The Chinese Economy Takes Over the Top Spot

Share of world GDP, measured in nominal US dollars
2010
Other Asia,
Pacific
20.5%
2020
Other Asia,
Pacific
33.8%
Mideast,
Africa
5.8%
Japan
8.7%
Emerging
Europe
6.4%
North
America
27.1%
Western
Europe
25.2%
Other
Americas
6.3%
North
America
20.1%
Japan
5.7%
Emerging
Europe
7.5%
US
22.9%
China 9.4%
India
2.7%
Mideast,
Africa
6.1%
Western
Europe
19.6%
Other
Americas
7.1%
US
16.9%
China 19.6%
India
5.5%
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

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
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US
Europe
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
China
US
Global Ethylene Prices
Global Polypropylene Prices
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
US
Europe
Europe
China
2,800
2,600
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Southeast Asia
US
Europe
Northeast Asia
7
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)
Shipping Rates Are Not A Concern

(Baltic Dry Index, 1985=1000)
12,000
Abundant supply should

keep rates low for at least
the next three years
10,000
8,000
6,000
4,000
2,000
0
2003M1
2005M1
2007M1
2009M1
2011M1
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
10
How Does this Impact Chinas Cost Advantage?

US Production Costs for Steel Castings
(Source: 2010 Annual Survey of Manufacturers)
Payroll
Production
Management
Energy
Material
Scrap
Ferrous shapes & forms
Sand
Industrial equipment
Nonmetallic products
Nonferrous shapes & forms
Other
Cost ('000s)
5,412,793
3,880,981
1,531,812
1,499,672
10,881,765
5,651,202
2,560,415
512,083
292,619
292,619
329,196
1,261,919
Share
30.42%
21.81%
8.61%
8.43%
61.15%
31.76%
14.39%
2.88%
1.64%
1.64%
1.85%
7.09%
Production Costs
17,794,230 100.00%
Value of Shipments
27,100,175 65.66%
Chinese Production Costs for Steel Castings

(Source: 2010 Annual Survey of Manufacturers)
Payroll
Production
Management
Energy
Material
Scrap
Ferrous shapes & forms
Sand
Industrial equipment
Nonmetallic products
Nonferrous shapes & forms
Other
Production Costs
Cost ('000s)
1,353,198
970,245
382,953
1,499,672
10,881,765
5,651,202
2,560,415
512,083
292,619
292,619
329,196
1,261,919
Share
9.85%
7.06%
2.79%
10.92%
79.23%
41.15%
18.64%
3.73%
2.13%
2.13%
2.40%
9.19%
13,734,635
100.00%
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
The Chinese cost advantage is 23% in 2010
11
Cost Erosion Continues In the Next Decade

Existing 23% Cost
Advantage
Eliminated by End
of Decade
(Cost Index, Steel Castings, 2010Q1=100)

170.0
160.0
150.0
140.0
130.0
120.0
110.0
100.0
2010Q1
2012Q1
2014Q1
2016Q1
US
2018Q1
2020Q1
2022Q1
China
12
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
13
Lower-Cost Countries Are Also Available

Global Manufacturing Wages (USD per hour, 2012)
Pakistan
Vietnam
Indonesia
Philippines
Thailand
India
Peru
China
Turkey
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
0.00
Depending upon your

location, Indonesia, and
Mexico may be good
alternative sourcing options
10.00
20.00
30.00
40.00
50.00
14
Indonesia Offers an Attractive Option

(Manufacturing wage, USD per hour)
8.00
6.00
4.00
2.00
0.00
2000
2005
Mexico
2010
China
2015
2020
Indonesia
15
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)
16
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
17
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
Additional Resources:
Commodities Through 2013

View Webcast | Download Report
Steel Buyers Guide

When Will China Lose its Low-Cost Edge?

Commodity Price Forecasts:
Copper
Stainless Steel
Polyethylene
18

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Has China Lost its

Why the Concern about China?

status over the next 3 years

Should you be concerned?

No cost advantage for most material prices

How should this impact your sourcing decisions?

Chinas Rising Profile in US Trade

Source: IMF Direction of Trade Statistics.

Copyright 2013 IHS Inc. All Rights Reserved.

China Also Plays A Larger Role In Supply Chains

Copyright 2013 IHS Inc. All Rights Reserved.

The Chinese Economy Takes Over the Top Spot

Yet, Overall Labor Costs Are Still Very Low

$2.50 per hour

Strong upward pressures on wages

Productivity gains pushed 10% higher annually

However wide disparity exists across the country and occupation

another 10-15% in the next 3-5 years

No Chinese Advantage on Material Costs

Global Copper Prices

(USD per metric ton)

(US$ per metric ton)

Global Ethylene Prices

Global Polypropylene Prices

(US$ per metric ton)

(US$ per metric ton)

Copyright 2013 IHS Inc. All Rights Reserved.

Continued RMB Appreciation

(Canadian dollars per US dollar, quarterly averages)

(Euro per US dollar, quarterly averages)

(Yen per US dollar, quarterly averages)

(Yuan per US dollar, quarterly averages)

Copyright 2013 IHS Inc. All Rights Reserved.

Shipping Rates Are Not A Concern

Abundant supply should

Copyright 2013 IHS Inc. All Rights Reserved.

Productivity Gains Have Been Strong

Productivity has almost doubled since 2005,

How Does this Impact Chinas Cost Advantage?

Chinese Production Costs for Steel Castings

Assume material costs are roughly equal

The Chinese cost advantage is 23% in 2010

Copyright 2013 IHS Inc. All Rights Reserved.

Cost Erosion Continues In the Next Decade

(Cost Index, Steel Castings, 2010Q1=100)

Copyright 2013 IHS Inc. All Rights Reserved.

Cost Saving Still Exists But For How Long?

approximately 23% lower than those in the US

risks do cut into these savings

margins are narrowing

from 10% of US wages to 25%

Copyright 2013 IHS Inc. All Rights Reserved.

Lower-Cost Countries Are Also Available

Depending upon your

Copyright 2013 IHS Inc. All Rights Reserved.

Indonesia Offers an Attractive Option

Copyright 2013 IHS Inc. All Rights Reserved.

No Country is Without Risks

Indonesia - Exporter Risk Rating - 11 (1-Year) / 34 (5-Year)

Copyright 2013 IHS Inc. All Rights Reserved.

Implications for Buyers

Labor was the primary advantage in China

But China is approaching the end of its low-cost status

cost countries (Indonesia) or ones closer to home (Mexico)