On the Perils of "Chasing Cheap Labor"

I once ended up on the same Qingdao-Seoul-Seattle flight as a long-time client and friend of mine whose company, among other things, had been hugely successful in China in an industry where just about every other foreign company had failed. The long flights gave us a great opportunity to talk and we talked a lot about business in China.

He told me about one of his offices in a third-tier China city and how he was running it. He loved the manager there and had given this person full hiring and firing authority and a cut of the rapidly increasing profits. I asked about the manager’s salary package and when I learned it, my eyes bulged. I commented that they could be paying this guy half as much and still getting the same effort out of him.

My client vehemently argued against me, using a whole arsenal of weapons. He said I was wrong, that he did not care about saving money that way, and that I was applying an employer mentality completely different than the one I used for my own law firm. He actually went a long way towards convincing me, and a couple of years later (after two of my firm’s other clients had told me that this one company was the only Chinese company from whom they would buy this particular product, even though it cost more) I was completely sold.

I thought of that plane ride today after reading an excellent post at the heretofore undiscovered (by me anyway) but exceedingly informative blog, China Manufacturing Leadership. [link no longer exists]The blog is subtitled, “facing new challenges with practical strategies” and though it is geared towards China manufacturing, many of its posts are writ large. In his profile page, the blog’s author, David Levy, describes his blog further as being “all about the changes that China-based manufacturing executives and front-line managers must make in their leadership to optimize operations in the face of the upcoming challenges.”

Levy’s most recent post is entitled, “Coming to China, but NOT for cheap labor: Obsessing about cheap labor without considering overall value can be pretty stupid.” He is right, of course. If cheap labor were everything, Afghanistan, Somalia, Yemen and North Korea would all be manufacturing centers and Germany and Japan would have no manufacturing at all. And certainly all China manufacturing would have long ago moved to Vietnam or Sri Lanka, as a few bloggers have been predicting.

Levy makes this point the best way possible, with a real world example of which he was an integral part:

About 10 years ago, I was hired as the sourcing director for ***** Electronics, a privately held company headquartered for over 40 years in southern California. We were a smallish power supply company, supporting OEM projects for some major players in the medical, commercial and sometimes retail electronics markets. We had no China facility, and relied on our Taiwanese suppliers to realize the designs, make the products and ship them to us. My job was to setup and run a small liaison office in Taiwan, managing the development and sourcing of power supplies with our Taiwanese OEM and ODM vendors, and ensuring the quality of products made by those vendors in their Taiwan and Chinese factories.

Previous attempts at outsourcing in Mexico had failed miserably, and now it was time to try Taiwan as a manufacturing center. Prior to my arrival, Taiwan wasn’t working either. It was clear that Taiwan wasn’t “working for us” because its factories in Taiwan didn’t have the quality understanding to satisfy our market’s demands, and their factories in China (where an increasing number of our products were being made) didn’t have the flexibility to “buy into” our high-mix low-volume high-value model. The results: projects sold to major customers got to market late, or never made it to market at all. Most damaging were product recalls for power supplies sold to Bloomberg and Kodak.

Various manufacturing and operational problems in Taiwan were proving insurmountable so the decision was made to go to the Mainland:

So it was decided sometime in 1999 that we would solve these problems by setting up in China. When I mentioned to our current vendors that we would be setting up in China, they tended to snicker as they mumbled “chasing cheap labor”. My dirty little secret was out, as if I’d winked while mentioning I was “going for a massage.”

This was when labor WAS still cheap in China, but cheap labor was not even CLOSE to being the driver for the move. This facility was set up (and remains) in Shenzhen city (in Nanyou), which is a much higher cost setting than where any of our competitors had set up (usually in Shenzhen’s outskirts, or in Dongguan). We paid our people more, and spent more on housing and other benefits than our competitors did (many called me stupid to do this, and warned me against “spoiling” the workforce).

What we chased, or what we caught, was a stable and flexible workforce. In retrospect, cheaper labor would have been much more costly. That facility, with its high labor costs, started on a shoestring budget, grew to take in all previously outsourced production, and grew an R&D function which was intended as a “back office” to the US R&D facility. In the end that too became the driver of our company’s R&D capability.

So we came to China and paid our workers too much, spent too much on their benefits and too much on ensuring their comfort and safety. And all we got for all this “cost” was LEAN, flexible, and otherwise value-added production. The value, added by this flexible and stable workforce, was not lost on the market, and as we added Fortune 500 companies to our customer list, our value and stature grew. Finally the operation was purchased by a competitor.

Levy has since left that company, but that company remains in South China and it never mentions “moving out of southern China to chase cheap labor.”

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