8 March, 2004
China and Commodities

My experience over the course of the last 31 years has been in developing sales and marketing for quality U.S. and European manufacturers of hand tools and power tool accessories within the Asia Pacific Region. The trend has been for many companies to rush into the sourcing of product from China and Taiwan. It is my view that, while in some cases this does make sense, it appears that some companies are doing this far too quickly. The lure and admitted reason by many companies, of course, is low cost labor. The desire to reduce S.G.& A resulting in improved bottom line and hopefully improved value of their stocks on the market. Labor, with some exception, usually represents about 15% in terms of cost for most manufacturers within the industry. It is the elimination of employee benefits however which is the long term savings to these companies. In an effort to obtain the short term benefit from low cost Asian labor rates, many companies have ended up with additional costs that were either not anticipated or were under estimated. For example, increased inventory and more importantly the timing of the inventory to meet demands of their customers has resulted in additional costs. Many of the 'Big Boxes' have long ago learned to reduce their costs by letting suppliers carry the inventory in a lot of cases. Remember they have huge buying offices themselves and in many cases only carry the quality brands until to meet demands. Generic product is always available from them. The carrot is the quality brand. If it's not on the shelf, users are encouraged to try the generic brand. Quality needs are not always met by Asia suppliers and guarantees from suppliers are not always there as well. Sometimes this is a cost simply because of lack of communication or misunderstanding. Sometimes the same level of quality is simply not possible due to lack of the required commodities, e.g. steel, resins, etc. Deliveries are not always met as well. Additional charges are also incurred in terms of warehousing, economic container loading, trucking, documentation and shipping. In other words, many hidden costs that chisel away at that 'reduction in labor' that was anticipated.

Now, there is a new factor that will effect many companies. This will not only have an immediate impact on costs, but it is a glance into the future. Here is what and why: Shortly after the Lunar New Year, many commodities rose in value around the world. While there are many reasons for that, one of the major reasons may surprise you. It was the outbreak of SARS. This deadly virus caused a great deal of havoc in Asia, but primarily in China. Business came to a screeching halt. Many factories, out of fear of the virus, virtually locked their employees inside their compounds, divided them up into separate teams and tried to maintain operations. Business did slow down a great deal however. Then, around August and September, business came back. There was a giant surge in demand, thereby putting a strain on existing inventories of many commodities such as steel and oil. Adding to the cause of this surge in demand was also the increased number of factories being built in China. In spite of SARS, China's fixed asset investment, which accounts for almost one half of China's economy, grew 27 percent in 2003. Industrial production grew 19 percent in January, the fastest since 1995. China already is the sixth largest economy and consumes 55 percent of the world's cement production in 2003 and 36 percent of the world's steel production for the same period. Prices of steel both in Taiwan and in China have shot up between 35 and 45 percent recently. Some say these will stabilize in the last quarter of 2004. That remains to be seen. Steel production in the U.S.A. is just about gone as I understand it.

So basically we have an under developed country with one billion people, which is the sixth largest economy in the world today, consuming 55 percent of the world's steel and 35 percent of it's 36 percent of the world's steel, selling 'low cost labor' to the rest of the world. Add to that the fact that the Yuan is highly undervalued in its pegging to the U.S. dollar. The economy is growing very quickly and the curbing of inflation will be a major challenge. What happens when the demands for those commodities, which are already stretched, becomes even higher just to meet the demands of the China domestic economy and the Yuan revalues? Will all those savings in 'labor costs' continue to be realized? Time will tell. But for now, this is only a small indicator of the future. Anyway, those are some things I've heard along the road.