Addressing the Challenge of China's Labor Cost Advantages
By M Dana Baldwin, Senior Consultant, CSSP, Inc.
Let's start by stating the obvious: China has a considerable advantage in producing many goods because of its low cost of labor. Recent statistics have indicated their average cost of manual labor averages less than $1 per hour, while the United States is averaging nearly $20 per hour, fully burdened.
How does one compete with this extraordinary cost differential? Actually, there are a number of ways to offset this advantage, in the right circumstances. To analyze these situations, let's first look at how we compete in the market place, and how we position our products. To do this, we must first analyze our product positioning.
Is your company's product a specialty item or a commodity item? In other words, does your company actually compete on features and benefits, or on price? Why is this important to determine up front? Whether your product is a commodity or a specialty product will indicate how you must compete. If your product is positioned as a specialty product, it means that you compete principally on the features, benefits and the perceptions of your buyers that your product is competing to reach. Prices are usually set based on what the market will bear, not just on cost. There can be multiple winners in specialty market places.
If your product competes principally on price, with minimal external services wrapped around the product, your positioning likely is in a commodity market. In commodity markets, there normally is one winner, the low cost producer. Other participants in this market place are allowed to be there at the mercy of the low cost producer.
How should your company compete with the lower cost labor advantage of China if you are a specialty producer? First, you should determine what makes your product a specialty product. In analyzing your offerings, try to determine why people or companies are willing to pay you a premium for your product over the lower priced commodity offering from China. You must determine what features they are willing to pay you an additional premium for. What makes your product unique? How much premium will your buyers pay you for your product over the prevailing price in the market place?
To help determine this, you should ask your marketing staff these questions: "What features or services result in our customers being willing to pay us a premium price over our competition, even if that premium price is only a few cents per unit?" This is asked to help us determine why customers buy our product.
Next, you should ask, "What features do our customers expect as a "given" in our product?" This is asked to help you decide what the expectations of the buyers are.
Third: Ask, "What features are they NOT willing to pay a premium for and can we eliminate or minimize them without harm to our sales volume?" You will do this to find out what elements of cost can be eliminated without harming your sales.
Fourth: To define how you compete effectively in the market place you should ask, "What advantages do we have over our competition? Are these advantages sustainable or can they be copied (and how easily)?" This will help you define how you effectively compete for business and sales volume.
Fifth: you should analyze your competition. What does your competition offer? How do they compete in the market place? Is your competition's product price based or feature/benefit based? What do they offer that you also offer? What do they offer that you do not? Is there something you should incorporate to make your product better or more competitive?
Next you should analyze your own costs. Are there cost reductions you can incorporate which will - at the very least - not harm the perception of the product in the market place or which may enhance the value of the product or, alternatively, which will allow you to reduce price without harming margins or sales volumes? Are there production costs which could be minimized or eliminated which will help lower the total costs of your product?
Competing with the Labor Advantage if you are a Commodity Producer
The determining factor in competing with price is lowest cost. Very simply put, if you are not the lowest cost producer of a commodity item, you will remain in the market place only as long as your lowest cost competitor wants you to remain viable in this arena. At any time, the lowest cost producer can decide to monopolize the market place by lowering its selling price below your cost of production. Inevitably, sooner or later, you will be forced out of that market place.
So, how does one compete? One way we have been able to determine is to change the market place to your advantage. Easy to say, difficult at best to do. In our seminars, we often use windshield washer fluid as an example of a highly commoditized market. The winner of the business of supplying windshield washer fluid is the low price bidder. However, there is a smaller segment of this market which sells for a premium price over the standard blue fluid. Usually colored green, it provides additional capabilities for which some, relatively smaller groups of users will pay a premium price. The purveyors of the green fluid have changed their market place to allow them to charge more than the market price in a mostly commodity business. The question to ask in your particular set of markets is: "Are there any opportunities for us to provide a higher priced, better featured set of products which will appeal to their own niche, thus taking us out of the low price competition and into a niche we can be successful in for some extended period?"
Stating the obvious: We most likely cannot compete against a competitor which will charge as low a price as needed to get the business, no matter what. If your only basis of competing is price, you may well have a problem unless there are other factors which you can use to create a competitive advantage.
To understand where the products from China are positioned in the market place, we need to look at the characteristics of how Chinese manufacturers gain an advantage or possibly suffer a disadvantage relative to a US manufacturer. How does a manufacturer located over 6,000 miles away across a wide expanse of ocean compete with a domestic manufacturer other than in providing a lower cost product? What are the characteristics of their competitive situation that we need to understand in order to be an effective competitor with them?
First: We must understand that the products coming from China have a reasonably long lead time. Depending on the manufacturing cycle times, it can be two to four months between placing an order for goods and their receipt at the point of sale.
Competitive point: If you can convince your buyers that short lead times are a key to their productivity and profitability, you may have a distinct advantage in the market place.
Second: In China, their culture is both an advantage and a disadvantage. Once an order is given to a Chinese worker to do a specific task, the worker will follow the instructions to the letter. While this can be an advantage in getting many operational steps completed in rote order, it also means that any problems encountered may take a long time to be corrected. They tend to focus directly on the problem at hand, and not to think ahead for any unintended consequences of their actions.
For example, in researching for this article, we interviewed people who have businesses in China that supply products for the Chinese and export markets. One of the resources we interviewed told us about a driveway to a factory being built which was poured four times before the project was complete. Initially, the work order was to pour the driveway. They poured it, then they tore it up to run the sewer line under the drive and paved it again. Then they tore it up to run the water line, and poured it for a third time. Finally, they tore it up yet another time, and installed the telephone and power lines, and poured it a fourth time. The conclusion of our interview: Correcting problems likely will take much longer than we are used to. In China, they tend not to think ahead. They do exactly what they are told, and don't think about the consequences of their actions and what to do to avoid them. This does not mean that this will continue into the future, but at the current time, there are cultural issues which can have an impact on the effectiveness of their productivity and efforts.
Competitive point: Using the ingenuity and responsiveness of the typical American firm to quickly address and solve problems can be an effective competitive advantage.
Third: The culture of the Chinese also can hinder problem solving. We were told that they will tell you "No problem" when you discuss a problem with them. What that really means is that it is not their problem. They won't tell you if it is your problem or someone else's. They culturally cannot face a negative easily, so they "wish" it away by refusing to take responsibility for the problem.
Competitive point: Building on your responsiveness and ingenuity to solve problems, coupled with effective communications to build lasting relationships can help build a sustainable competitive advantage in many industries.
Fourth: Language can sometimes be a barrier to communications, even among the Chinese. Non-Chinese speakers encounter some language problems. This results in slowness at understanding and correcting problems. The more people involved in making a change, the longer it takes. In some factories, all employees are from a long distance away, they may speak a different dialect, making communication more difficult within the city in which located.
Competitive point: Again, your ability to effectively communicate and to be responsive to your customers' problems, challenges and situations may help you differentiate your company from the competition.
Fifth: You must understand that price of the goods or products involved is only one part of the equation. In addition to the actual price of the products, the customer will have to pay for packing, inland freight within China, ocean freight, offloading of the products or containers, inland freight within the USA and any tariffs or duties involved. The total of all these costs are what you are competing with, not just the product price. Do not confuse low cost of labor with low cost production. While the individual worker in a Chinese factory earns a low wage relative to the US worker, the total number of hours to produce products may be much higher than we would expect if performed in this country. However, offsetting this is the ability of the Chinese government to set prices, trading profitability for greater employment.
Competitive point: Be sure your customer understands the entire supply chain and its associated costs and risks. They may try to get you to lower your price based on the price of the product in China, but there are many other contributors to the final cost which likely will be in your favor. In the longer time span between order and delivery, there are more elements of risk, such as damage in shipping, pilferage, delays and hidden costs. Where possible, use these exposures to strengthen your case.
Sixth: If there is a requirement for high human input into a product, in China, there is much more opportunity for error. The average Chinese worker is not likely to be able to solve problems, but will tend to continue to make the same rote mistakes until the process is changed from above. This may be important for the consistency of the products made in China.
Competitive point: Emphasize your products uniformity and consistency along with your quick responsiveness and flexibility to meet your customers evolving needs.
Now that we have established the basis for understanding our positioning in the market place, along with the positioning of our Chinese competition, we need to look for sustainable competitive advantages which will help us maintain our sales volume and profitability. This also will involve answering a series of questions about products, markets and positioning.
So, bottom line, how can we compete against a competitor that is determined to dominate a market through lowest cost labor? As listed above, there can be a number of ways to address this problem.
If you are in a commodity market, you need to look into how you might change the basis of competition. There definitely will be opportunities which will not be available to you if the Chinese decide to compete in your market place. But you need to establish means to compete in niches where they have not yet decided to provide products. These could include: Finding niches where some form of specialty product is a key to gaining volume. This could involve being able to make minor changes quickly, so that the two to four month lead time from order placement to delivery is overcome with your quick deliveries and responsive problem solving capabilities.
Second: Work to persuade your buyers that your company will be a consistent source of supply for them. You should emphasize that you are not subject to shipping delays due to ship schedules across the Pacific Ocean. Also, you are not subject to port backups, due to heavy volumes of container and conventional ships arriving at a limited number of US ports. You also are not subject to delays due to longshoremen's unions, etc.
Unfortunately, when it comes to higher volume products with few opportunities to change features, and longer lead times, there often is little one can do to offset the cost advantages of China. Mostly this applies to commodity types of products, but there are increasing instances where more specialty items are beginning to be sourced in China as well.
As far as dealing in a specialty product, you may have some distinct advantages. Some of them are the same as above: Responsiveness, flexibility, problem solving capabilities, quick turn-around, ease of making small changes quickly, etc. Another consideration is being able to offer a product that must be sourced locally or regionally. For example, currently it is very difficult to repair a piece of machinery from far away. So a plan of attack might be to tie periodic maintenance and repair services into the initial order process, to build your relationship with the customer and make it more difficult for an exporting country to win business.
Another competitive advantage could well be gained by working closely with prospective customers to improve or change features of your products to meet their individualized needs. This type of responsiveness helps build and keep business for you company.
Yet another potential competitive advantage may exist if you have technology which is unique and protectable. This should be exploited rapidly, and efforts made to continually update and build on this sustainable competitive advantage.
All in all, competing with labor costs and product prices which are so much lower than US sources is extremely difficult. Finding ways to discern and take advantage of whatever competitive factors we can develop, along with building relationships based on our effectiveness in meeting the customers' needs, are what is needed to compete in our global economy.
Dana Baldwin is a Consultant with Center for Simplified Strategic Planning, Inc. He can be reached via e-mail at
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