SCDigest editorial staff

The News: Just relying on low cost labor in China is not enough to achieve results anymore, a report in the McKinsey Quarterly notes

The Impact: Companies outsourcing production to China must use many of the same “Lean” techniques – and drive out inefficiencies – to regain competitive advantage.

The Story: Many Western and Japanese companies have of course outsourced production to China, but just a subset of those are gaining any real competitive advantage. This is due in part to a variety of costs (inventory, logistics) that must be incurred in synch with the move to China, but increasingly because as more and more competitors make similar moves, the industry simply move back to a steady state.

For awhile at least, companies can regain some competitive advantage by focusing on greater efficiencies in Chinese operations, and adopting many of the same Lean concepts employed in Western operations, a new article in the McKinsey Quarterly notes,

Low Labor Costs Not Enough

“So many companies now produce goods in China that simply relying on its low-cost labor to churn them out inexpensively confers precious little competitive edge,” the McKinsey articles notes. “Overcapacity in many industries—from automobiles to household appliances—is already leading to price wars, squeezed margins, and, in some cases, heavy losses. Even Chinese exporters are feeling the pinch as global players move in and enjoy cost advantages similar to those of local producers.”

With the tremendous growth both in manufacturing for export and for its own domestic market, Chinese producers generally just throw more equipment and labor at the need to expand, rather than look to generate more capacity through greater efficiencies. Factories are often created in just weeks. As a result, “Waste is endemic in Chinese factories—those owned by multinationals and by locals alike. Machines often sit idle, inventory piles up, bottlenecks choke production,” McKinsey says. “Parts deliveries from suppliers arrive late. Defect rates for components run high. So long as the advantages of low-cost labor were substantial and competition was limited, companies tolerated such inefficiency. Now that margins are shrinking, they have little choice but to find ways of raising their productivity and of improving the quality of their goods.”

Some of the specific issues include:

• Quality is often ensured by post-production inspection and rework, rather than focusing on improving the manufacturing process itself to build in better quality. A high level of scrap is often accepted.
• Big production runs lead to piles of inventory that is prone to damage as it sits around for long periods waiting to be shipped.
• Poor material flows in the factories and between the factories and suppliers, meaning operations often halt or slow down as processes wait for needed components or materials.
• Poor equipment maintenance practices lead to a substantial amount of shipment downtime.

These challenges may have been manageable for the first companies in an industry moving to China, but now provide a needed source of opportunity for companies to gain further competitive advantage as the basic move to China becomes a common strategy.

Techniques to Get Lean

A recent McKinsey survey of 30 electronics factories found that wasteful practices and high defect rates decreased profits by 20 to 40 percent compared with returns at world class plants. If the average factory in this survey group matched the top performers, profits would rise by about $25 million a year.

How to get there? While the basic techniques of Six Sigma, Lean, material flow, etc. are of course well understood by many Western companies, McKinsey offers some suggestions on how to make them work in China:

• Build the Know-How through recruiting talent from other Asian countries: Some companies are starting to recruit production and supply chain experts from South Korea, Japan, and Taiwan, for example, due to the scarcity of the managerial resource pool in China itself, often using recently retired engineers.
• Rethink floor level training: Western approaches to training may need to be revamped. Training curriculums must be much simpler, and sessions must convene more frequently. Chinese workers tend to learn faster from hands-on shop floor exercises than from the theoretical classroom sessions typical elsewhere. There is a need for experienced instructors who can roll up their sleeves.
• Create a performance culture: Chinese managers spend most of their time fighting fires and not managing overall performance, with little experience using advance management tools or analysis. It is uncomfortable for Chinese managers to talk to employees about their specific level of performance. It is therefore critical to choose a strong leader who can lead the change to a more performance-driven culture, with a focus on the right set of metrics. Here’s a hint: don’t focus targets around unit output.
• Focus on sustainable gains: Chinese managers tend to bask in small, one-time improvements that solve an issue, but not on long-term, continuous improvement. Communication and training must be must broader than in Western operations to gain worker buy-in. Smart “pilots” should be deployed, and results widely touted. Attention should be paid to developing a cadre supervisors who “get” the opportunity and server as factory “evangelists.”
• Alter traditional timelines: The pace of change in Chinese factories is often so great that traditional Western perspectives on implementing operational improvements may be too slow. By the time the change initiative is implementing, to much operational change has occurred. “Companies must give lean initiatives shorter time horizons than they have elsewhere and implement them more swiftly,” McKinsey writes.

 “We’ve seen many companies moving further west into China chasing lower labor rates, as wage pressures in the major eastern cities grows,” notes SCDigest editor Dan Gilmore. “Perhaps more companies should be looking to improve their Chinese operations or those of their suppliers, as the wage advantage becomes increasingly commoditized across industries.”

Do you agree companies need to get their Chinese operations more “Lean?” Is the wage advantage of China going to be quickly commoditized across industries? What recommendations do you have for improving efficiencies in China operations? Let us know your thoughts