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  May 11 , 2006 - Supply Chain Digest Newsletter
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First Thoughts by Dan Gilmore, Editor

Risk in the China Strategy?


As I hear and discuss the supply chain and “offshoring” strategies of many companies, part of me is surprised at how aggressively it seems many of them are moving headlong into China without looking hard at the mid and long-term supply risks.

Obviously, China offers an incredible opportunity: low costs, very good/excellent quality, outstanding outbound infrastructure, and, of course, a potential domestic market that boggles the mind.

It’s no wonder, as we asked some last year in Is it Global, or is it China?, that the move by western companies to China for manufacturing is incurring at an incredible rate.

Still, I have recently had a few conversations that make me wonder if companies are not taking on too much risk by the mad rush to take advantage of China’s low costs and tantalizing market. Specifically, it seems to me an “over-reliance” on China is very risky given potential dynamics along a number of variables, as I’ll outline below. Nonetheless, I hear from many companies that are not well hedging their bets in the great migration of manufacturing into China.

What are the risks? Seems to me there are three important ones, which I list below, roughly from least to worst:

  • Trade war/protectionism: While the move to China can often offer dramatically lower unit costs, the total cost benefit in the end is usually much less than that. The outbreak of any major “trade war” or protectionist barriers that include high tariffs or other cost increases could change the sourcing economics dramatically. Can’t happen? Think again. The odds of major barriers are small – the trade is too important to both sides – there has been a lot of saber rattling lately. A change in the political leadership here, fallout from pressure on wages from Delphi and others (see Delphi, the UAW, and Everyone’s Supply Chain), and other factors could push things over the edge. Former Treasury Secretary Lawrence Summers calls the U.S.-China trade dance a “balance of financial terror.” And while most understand a trade war would be damaging to both sides, “Don’t bet on that logic holding,” The Wall Street Journal recently reported.
  • Intellectual Property: Every week, it seems, brings some news of Intellectual Property issues in China. The latest is consumer electronics company NEC, which had dozens of its products virtually cloned by Chinese counterfeiters, down to purchase order paperwork. But that’s just one of many, and not even representative of the real risk, which is having suppliers appropriate designs and IP and become competitors both in China and globally. Cisco, Motorola, GM, and many others have had significant IP issues in China. As manufacturing expertise becomes commoditized, all that’s left is the design and brand – and there’s big risk in moving too much of that offshore with the production.
  • Political: Although greatly relaxing most economic freedom, China is still run by Communists, after all. There are two big questions: (1) will growing economic freedom and prosperity eventually lead to political freedom as well, or will at some point the government come down hard on demands for these reforms? (2) What will happen between China and Taiwan, and could rising and falling tensions there potentially lead to actual military conflict, which could drag the U.S. into the fray? Taiwan could at any time elect a leader who raises tensions with China to the boiling point. Either scenario would radically disrupt many supply chains.

Obviously, these risks need to be balanced against both supply and demand side benefits. It’s clear many companies see a potential bonanza in the Chinese market, and believe correctly they need a manufacturing presence there to really capitalize on the opportunity. Companies like Motorola that have invested heavily in China are starting reap significant market rewards – billions in cell phone and related revenue in Motorola’s case.

Still, I think companies committing nearly everything to a China supply strategy need to really look at the whole equation, and find ways to mitigate these risks so that if down the road there are issues, you don’t find your only supply chain strategy is a China strategy.

The global economy will in the end be stronger for everyone if China continues its journey to being a good world citizen. But I’d be hesitant to get in so deep that my company was really at risk if China one day decides to launch a few missiles over towards Taiwan.

In my conversations, I am convinced many companies act as if there is no chance it could happen, and do so at their company’s risk.

Are there real risks associated with trade wars, IP and politics in China, or not to worry? Are companies adequately planning for and considering these risks, or is the rush to China too alluring for many to balance risk reward? How do you get the right balance? Let us know your thoughts.

Let us know your thoughts.

Dan Gilmore


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Q.  What percent of Procter & Gamble's Business is through Wal-Mart?

A. Click to find the answer below


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Feedback is coming in at a rate greater than we can publish it - thanks for your response.

Catching up a bit, we include some more letters on on Delphi, the UAW, and the Supply Chain. This includes our feedback of the week, from Lee McMillan of Marksmen Management & Research, who agrees this will be a key inflecxtion point in labor costs, but says the real start was the Caterpilar-UAW union conflict more than a decade ago.

We have more letters on this topic, plus one of our review of the North American Material Handling Show, who says we missed some interesting developments in racking technology.


Keep the dialog going! Give us your thoughts on this week's Supply Chain topics. As always, we’ll keep your name anonymous if required.


Feedback of the week - on "Delphi, the UAW, and the Supply Chain":

Yes, it will be the real inflection point in above-average Union wages, but I believe it's like the Titanic with its narrow bow already plunging and what you see is the bulging stern; the Union 'ship' has been sinking for over a decade with 'icebergs' hitting it via the Caterpillar management-imposed contracts, the 'soft-deals (where Unions 'agree' with management that Total Labor Costs must be reduced at lease a little), with the Farm Equipment suppliers, the steering of union-work to non-union suppliers with, again, 'soft-deals', the shifting of vehicle production to Mexico, again via 'soft-deals', and most subtle of all are the constant pressures on all automotive parts suppliers (this would be the 2nd-3rd-4th tiered small 'shops', either Union or partly- Union or non-Union to do 'more work', i.e. parts production, overseas in Asia (1st it was Formosa and then Korea and now China) and Eastern Europe.  It is 'commonly believed' that some 50% of total Automotive parts were non-Union BEFORE the big China-Push!

In our opinion, your best model and thus further source of investigation should be the Caterpillar-UAW situation which began with a lockout some dozen years ago; that's when the Union-Titanic ship began to 'list'. 

Lee McMillan

Senior Investment Analyst

Marksmen Management & Research

More on "Delphi, the UAW, and the Supply Chain":

I think that Delphi's problem will be solved if we can solve GM's problem. GM has to fork out retirement for almost 460,000 retirees. This is a very heavy burden. What is good for USA is also good for GM. GM's CEO should show intuitive and courage and push for Universal Health Care. Also, GM should work on car with much better gas mileage and models so that fellow Americans will purchase the cars. Solve GM problems and Delphi's problem will be no more.


I am trying very hard to associate Delphi's problems with infliction in the well accommodated union jobs. I do not see it. A Democracy as powerful as our country has not other option than provide good pay and compensation for the "low" skill workers. This is imperative of civilization and not economics. Wal-Martization of America is not a viable option.


Ara Hakopian


I think the Union wages in many companies has fast forwarded the flow of outsourcing overseas.  I hope this is successful and long overdue as we must be “worldly competitive” in order to keep jobs in the US. 

Richard Milhollin, CEO
Integrated Logistics Management Solutions

On North American Material Handling show review:

I to was at the show and agree with your assessment that it seemed to be scaled back substantially from the ProMat in Chicago last year.


However, I would like to point out two introductions of HUGE changes in storage racks.  Yes, I know that storage racks are not anywhere near as sexy as a robot truck loader or web based scheduling of dock door availability but none of the warehouse operations will work without storage rack.


Ridg-U-Rack introduced the first "seismic base isolation" unit for storage racks.  This is a device that attaches to the bases of upright frames and absorbs the energy from an earthquake, thereby reducing the affect of the earthquake on the rack structure and the loads placed on the rack.  This device will revolutionize the design of storage racks in high seismic areas, will result in much better designs of upright frames and enhanced safety in a warehouse store environment.  I congratulate Ridg-U-Rack on the extensive research, development and full-scale testing on the seismic simulator shaker table at SUNY Buffalo.


The second change introduced is huge to the rack industry but I'm not sure as to the benefit to the warehouse operators.  Interlake introduced the first bolt-together roll-formed rack frame produced by a US company.  This type of frame has been used extensively in Australia for tax reasons and in Europe for shipping reasons but the US has usually used an all-welded frame.  While my company produces an all-welded frame, I can understand the attraction for the producer.  I believe the all-welded frame offers superior stability, alignment, and abuse resistance. 


Only the marketplace will judge the viability of both of these innovations but you should not overlook either in you zeal for the electronics and/or automation.

Dan Clapp


Q. What percent of Procter & Gamble's Business is through Wal-Mart?


A. About 16%, according to recent financial documents submitted to the SEC

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