China’s Interior: The Pros and the Cons

In Moving back to America:The dwindling allure of building factories overseas,  The Economist predicts foreign companies will be moving their manufacturing away from China in the years to come

When clients are considering opening another manufacturing plant in China, I’ve started to urge them to consider alternative locations,” says Hal Sirkin of the Boston Consulting Group (BCG). “Have they thought about Vietnam, say? Or maybe [they could] even try Made in USA?” When clients are American firms looking to build factories to serve American customers, Mr. Sirkin is increasingly likely to suggest they stay at home, not for patriotic reasons but because the economics of globalization are changing fast.

Sirkin goes on to say that by “around 2015, manufacturers will be indifferent between locating in America or China for production for consumption in America.”

In a recent pos, Don’t Leave China, Just Move! Jack Perkowski of Managing the Dragon Blog cites to the Economist article, but calls on companies looking to leave China to simply move to a cheaper Chinese city inland. Perkowski argues “there is still a strong case to be made for China,” including its huge population and economy. He then sets out the following “five reasons why companies should consider setting up operations in less travelled parts of the country”:

1. Improved infrastructure. China’s road and train system has radically improved.

2. Lower costs. “Other than perhaps transportation to the country’s ports, costs are decidedly lower in second and third-tier cities in the interior. Labor, land, construction, management, supplier and overhead costs are all significantly lower than in the larger, more established cities in the coastal areas.”

3. Strong Local Government Support. “I’m a big proponent of the “big fish in a little pond” approach to site location. In China’s smaller cities, your factory may be one of the largest and best companies to work for in the area. As a result of its importance, it will receive strong support from the local government. The party secretary and city mayor will welcome your investment, large or small, and will bend over backward to help you develop your business. This can take the form of streamlined approvals, access to bank loans, less red tape and less hassle from local bureaucrats.”

4. Lower Management Turnover. “If you offer attractive employment opportunities to the local residents, they will have little incentive to look elsewhere.”

5. Enhanced Insight Into China’s Vast Local Market. “Locating at least some of your operations in less developed parts of the country will provide your company with valuable insights into China’s much larger local market.”

Before I counter the advantages Jack cites to locating in China’s interior, let me state the obvious. Jack Perkowski indisputably knows way more about manufacturing in China than this desk-bound lawyer.

Now for my counter, based not on any direct experience, but on what my law firm’s international manufacturing lawyers hear from our manufacturing clients:

1. Improved Infrastructure. China is in the midst of what the State Grid Corporation of China is predicting will be its worst power shortage ever. I would bet the old manufacturing standby locations in China will do far better in getting power than the inland upstarts, for reasons of both physical infrastructure and politics.

2. Lower Costs. I do not disagree with a single thing Jack says on this, but our clients bemoan lower worker productivity in China’s smaller cities. And though I cannot back this up with anything approaching scientific evidence, I get the feeling that the more remote in China one goes, the greater the risk of having insurmountable (and expensive) legal difficulties with Chinese partners, buyers, and vendors.

3. Strong Local Government Support. Yes, this can be great while you have it, but Beijing is increasingly cracking down on improper local concessions and, more importantly, local government support can quickly disappear. Our China FDI and dispute resolution attorneys get a disproportionate amount of work involving ventures that have gone wrong in China’s more remote regions and in none of these matters did the local government favor the foreign company over the Chinese local. In places like Guangzhou or Suzhou, the local government is more likely to remain neutral.

4. Lower Management Turnover.  I have no basis to dispute this, but we have also heard from clients that one also has to deal with lower management quality.

5. Enhanced Insight Into China’s Vast Local Market. True enough, but for many manufacturers, small city sales might be years or even decades away.

Perkowski ends his post with the following advice on which I completely agree: “In the end, you need to evaluate your company’s particular circumstances in making location decisions.”

China manufacturing. Go inland or go home? And when? What do you think?