Melbourne Business School News How to know when it is time to move production from China

How to know when it is time to move production from China

Firms contemplating whether to move production from China to Southeast Asian countries don't always have all the facts at hand.

Man working in a manufacturing plant

Businesses are grappling with the rising cost of doing business, forcing manufacturers to look for new regions offering even lower costs of doing business.

And while China has long been considered a cheaper place to manufacture, researchers have found that the labour cost is rising significantly and there's a lot of uncertainty around the overall cost of production, particularly given ongoing political tensions.

To explore the challenge of improving procurement efficiency and reducing business costs, Dr Lusheng Shao from the University of Melbourne's Faculty of Business and Economics teamed up with Xiaole Wu from the School of Management at Fudan University in Shanghai and Fuqiang Zhang of Olin Business School at Washington University in Missouri, US.

Together, they set out to obtain a better understanding of what drives firms' outsourcing strategies. 

The trio developed a theoretical model of mathematical equations to capture the key factors that impact the cost in manufacturing offshore. This has been an important piece of research given that procurement is vital for a firm's success.

And while contract negotiations do take place to ultimately determine the price, Dr Shao says decisions on whether to proceed are being made repeatedly by businesses without all the relevant information at hand.

"The rising cost of doing business weighs heavily on the shoulders of our manufacturers. At the end of the day, the decision on where to manufacture comes down to much more than just the cost of labour," says Dr Shao, who is also an Academic Fellow at the Centre for Business Analytics.

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The trio warn that ultimately, shifting manufacturing to a new region that appears to offer a lower cost of doing business could cost more in the long run. Often, once you scratch the surface, you often realise that greater uncertainty can significantly impact costs.

Firms can't simply choose a manufacturing partner with the lowest labour costs when deciding where to source their products. A holistic assessment of cost scenarios is needed.

Electronics manufacturer Samsung moved its production out of China a couple of years ago, and a number of fashion brands have shifted production to Bangladesh. Dr Shao wonders whether these huge business decisions have ultimately paid off.

"In many cases, material and component costs account for a significant portion of the total cost. Therefore, improving procurement efficiency holds great potential for reducing costs and improving a firm’s bottom line," he says.

"There needs to be a trade-off between cost efficiency and the potential impact of cost uncertainty and information asymmetry. Such a trade-off can be quite involved these days as most firms operate in a global, competitive environment."

The fact is that many businesses overlook the many other factors to consider, including the maturity of the infrastructure in the country, transportation cost and geopolitical tensions, all of which could contribute to the overall cost of outsourcing, he says.

China's estimated manufacturing cost advantage over the US has shrunk to below 5 per cent, while Brazil is now estimated to be more expensive than much of Western Europe. These factors are driving companies to rethink their global supply strategies, Dr Shao says.

"At a high level, our research suggests that firms need to consider competitors' actions and their lack of cost information, as opposed to their suppliers', when determining sourcing locations and negotiating contract terms with their supplier," he says.

However, suppliers in Southeast Asia still remain mysterious to global buying firms due to a lack of previous interactions, which will inevitably mean you might not be getting all the facts – particularly around cost structures, he says.

"Market size plays an important role in determining the sourcing equilibrium. That is, reducing cost uncertainty doesn't necessarily benefit firms, which suggests that they need to be cautious when investing in uncertain activities or regions."

When the market size is too large, it's usually better to source from Chinese suppliers – otherwise, if smaller quantities are sought, it’s better to source from Southeast Asian suppliers.

While intuitively, a supply cost increase would mean a lower profit for the buying firms, it's not always the case when considering competition and asymmetry information for their sourcing decisions, he says.

"We determined that improving procurement efficiency holds great potential for reducing costs and improving a firm’s bottom line," he says.

To read the full research paper, visit Sourcing Competition under Cost Uncertainty and Information Asymmetry.

For more analytics information and research, visit our Centre for Business Analytics page.

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