Will China soon become the high cost option?
After the labour dispute between Honda and its striking workers, there has been a flurry of worry across the Middle Kingdom that workers in other Foreign Direct Investment and Joint Venture companies night push their own bosses for a payrise, and might just strike to get what they want.
Marketwatch speculates and worries us:
A sharp recent increase in minimum wages across several parts of China is raising worries about squeezed profit margins at manufacturing firms that may not be able raise prices to cover the increase in costs.
And while local manufacturers will still retain their competitive edge vis-à-vis global peers because of the relatively low base of wages in China, the sharp salary increases are expected to add to inflation at a time when the impact of the nation’s economic stimulus is fading, say analysts.
Such concerns were adding to the selling pressure on Chinese manufacturing shares Monday, following media reports that authorities have raised the minimum monthly salary in the Beijing by as much as 20%. The hike in the national capital came after several other Chinese provinces and municipalities announced similar hikes earlier this year.
Those hikes ranged from 5% in Hunan province to 27% in Ningxia province, according to analysts at Morgan Stanley, who estimated that based on the announcements by 11 Chinese provinces, the average increase worked out to 17%. “It is widely expected that many other provinces will soon follow suit,” they added.
Royal Bank of Scotland’s China economist Ben Simpfendorfer said the minimum wage increases were “inflationary” and that companies would struggle to fight the margin squeeze, especially in sectors that suffered from intense competition, or low-value adding industries such as appliances and toy manufacturing.
And while manufacturers cut down jobs in the wake of an increase in minimum wages in some cases, the development in China “makes it possible [for Chinese manufacturers] to move to a high-value added business model,” and is therefore a “good development,” he said.
“The low wage production model in China needs to change,” said Simpfendorfer.
He added that although wages in countries such as India and Malaysia were lower than in China, exporters with factories on the mainland were unlikely to relocate because of other factors, including a logistical advantage in China.
Morgan Stanley analysts also said that despite the “seemingly large minimum wage hikes, it should not be treated as leading to broad-based wage pressures or substantial erosion of low labor cost competitiveness in China, in our view.”
The reason for this, they said, is “the magnitudes of minimum wage adjustments lag the average wage and nominal gross domestic product growth by a wide margin. The latest round of rather large minimum wage adjustment has, in part, reflected the need to make up for the no adjustment in 2009, in our view.”
Labor troublesThe minimum wage increases across China coincide with simmering labor discontent in the country, evidenced by a recent strike at a Honda Motor Co. /quotes/comstock/13*!hmc/quotes/nls/hmc (HMC 29.86, -0.92, -2.99%) (JP:7267 2,825, -4.00, -0.14%) manufacturing plant that forced a temporary shutdown of the Japanese automaker’s production in China, and by several suicides at a Foxconn International Holdings’ manufacturing unit in Shenzhen.
Trading in shares of Foxconn /quotes/comstock/11i!fxcn.y (FXCNY 14.95, -0.17, -1.12%) /quotes/comstock/22h!e:2038 (HK:2038 5.66, -0.33, -5.51%) was suspended shortly after the Hong Kong market opened Monday, pending a price sensitive announcement, which some media reports said was about a sharp increase in worker wages. The shares fell 5.5% before the trading suspension.
In a note to clients released Monday, Yuanta Research downgraded Chinese automobile manufacturer BYD Co. /quotes/comstock/22h!e:1211 (HK:1211 63.50, -3.20, -4.80%) /quotes/comstock/11i!byddy (BYDDY 82.31, -0.74, -0.89%) , Brilliance China Automotive Holdings /quotes/comstock/22h!e:1114 (HK:1114 2.43, -0.03, -1.22%) and Great Wall Motor Co. /quotes/comstock/22h!e:2333 (HK:2333 12.50, -0.66, -5.02%) to hold from buy, and cut the ratings on Denway Motors /quotes/comstock/11i!denmy (DENMY 22.01, +2.36, +12.01%) /quotes/comstock/22h!e:203 (HK:203 3.54, 0.00, 0.00%) to sell. Analyst Johnny Wong wrote in the note that following last month’s strike at Honda and other recent developments, “we believe that the risk of wage inflation for the auto manufacturers has significantly increased.”
“We believe that most of the auto manufacturers will not be able to fully pass on increased labor costs to the consumer, given the slowdown in the industry’s unit sales,” Wong added.
Among Chinese automobile shares traded in Hong Kong, BYD shed 5.2%, Great Wall slumped 5.5%, Brilliance shrank 1.2% and Dongfeng Motor Group plunged 7.1%. Shares of SAIC Motor Corp. fell 3% in Shanghai, while FAW Car Co. shed 2.7% in Shenzhen trading.
In wider market activity, Hong Kong’s Hang Seng Index fell 2.5% and China’s Shanghai Composite lost 2.1%, with Japan’s Nikkei Stock Average sliding 3.7%, Australia’s S&P/ASX 200 falling 3%, South Korea’s Kospi dropping 2.3% and India’s Sensex declining 2.3%.
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They shouldn’t need to pass on the increased labour costs to consumers. Cars here are actually quite overpriced considering the costs involved in producing them. Foreign automakers will continue to make good profits here, even with the recent labour increases.
Just tell me why a Chinese JV-made A4 costs so much more than the German-made ones that are sold in North America?
The reasons are :-
1)The Chinese partner in JV contributes little but gets the same amount of profit as the foreign partner.
2)The foreign partner will get the same amount of profit as that in US.
3)Critical components are from the foreign partners’ own suppliers where there is a delicate pricing strategy.
If you add all those factors up, no wonder all JV-made cars are a rip-off in China. Even a 100% pay-rise to the auto workers in JV will not affect their profits. However the local auto industry will face drastic increase in labour cost.
Thanks, this is really good info. I hadn’t considered that there were “two mouths to feed”, so to speak. But it makes sense.
@ Gerald
> Just tell me why a Chinese JV-made A4 costs so much more than the German-made ones that are sold in North America?
High tariff on imported parts plus profit sharing with JV partner.
This is why Ssangyong auction has become hot with six bidders in the running, because the forthcoming China-Korea FTA heavily pushed by Chinese leadership would enable Korean-produced cars to be sold in China without tariff. Between China and Korea, Korea is so much nicer place to build cars even with $70K/year average salary. Once again, it’s the efficiency, not salary, that determines an automaker’s cost.
“Korea is so much nicer place to build cars…”
Only for Ssangyong, which is pretty much a failure.
China was never a low-cost option for automobiles to begin with, it simply costs more to build an Accord in China than in Japan according to Honda. Low wage alone isn’t able to offset the high cost of imported parts and transportation(This is a killer).
There is a good reason why all Japanese and Korean auto plants are located beachside complete with in-factory port, to save on shipping cost. Japanese and Korean transplants located deep inland are for local consumption only.
Now how many Chinese auto plants are located beachside?
Salary means little in overall auto manufacturing cost; it is stuff like transportation and efficiency that are the biggest cost factors, and Chinese claim no advantage over Japanese/Koreans in this regard.
This is why I keep saying that China will not become an auto export power like Japan and Korea before them, because low-wage doesn’t matter in auto industry.
“Low wage costs doesn’t matter”
Actually, it does. Chinese manufacturers are able to produce way cheaper cars in China than in a place like Korea. It is simply cheaper for them.
“That’s why I keep saying that China will not become an auto export power like Japan and Korea before them”
Do you need a reason why to say that? Just look at your name. You just wait, you will have to eat your words in 1-2 decades.
Ed,
Can you explain how a Nissan X-Trail, and a Renault Koleos are priced the same? The first is made in China, the second is made in Korea and imported into China, both share the same platform, engine, and many other components, both cars are priced pretty much the same depending specification wise, despite one being an import.
How is this possible?
I said CHINESE manufacturers, not Nissan or Renault. Read my comment carefully.
@ Ed
> Actually, it does. Chinese manufacturers are able to produce way cheaper cars in China than in a place like Korea. It is simply cheaper for them.
There isn’t much of a price difference between a Chinese car and a Korean car in places like Germany and Australia.
And no, Koreans aren’t dumping their cars in those markets, they are making their money.
> Do you need a reason why to say that?
Chinese auto market and industry looks like that of the US, which was never an auto export power.
> And no, Koreans aren’t dumping their cars in those markets, they are making their money.
Very little money. Easy way to see that is to compare Hyundai-Kia’s revenue with Honda’s. Hyundai-Kia sells more cars, but their revenue is much smaller than Honda’s.
> Chinese auto market and industry looks like that of the US, which was never an auto export power.
Being like the US is not bad at all. American automakers were the biggest in the world for decades (and they are still big). And while they didn’t export as much as Japanese automakers in percentages, they had decent numbers.
IHC, please explain to me why Honda make the Jazz/Fit in Southern China and export to the European market. Are you talking about something just out of your own imagination or Honda is as stupid as just what you have said?
As far as your FTA fantasy on future Korean cars to flood the Chinese market is concerned, I am afraid your wishful thinking will never come true. Are you talking about closing the Beijing-Hyundi factories and export all Hyundi from Korea, this is a serious political issue that no Beijing officials will agree.
@ hk
> IHC, please explain to me why Honda make the Jazz/Fit in Southern China and export to the European market.
To win favors with Chinese government officials. Euro-market Fits have 90% Japan-sourced content(as opposed to Chinese market fits with only 60% content) and it doesn’t save money to export out of China, but it wins political favors instead.
I will give you another example. Honda and Toyota plan to continue exporting Accord and Camry from Japan even after the KORUS FTA is enacted, because it’s cheaper to ship from Japan and pay an 8% import duty than to ship from Kentucky/Ohio(Deep inland factories) and pay no duty.
> Are you talking about closing the Beijing-Hyundi factories and export all Hyundi from Korea
Beijiing-Hyundai and Dongfeng-Kia will continue to operate as is since Hyundai-Kia is running short on capacity anyway.
However, additional outputs will be shipped from Korea as there is no incentive to build new capacity in China anymore.
After all, why do you think Renault-Nissan, MM, Tata are eying a dud like Ssangyong, as well as GM which sold its controlling stake in Shanghai-GM to bail out Daewoo? They are all salivating on the prospect of a duty-free free access to Chinese auto market, without having to deal with Chinese JV requirement.
> this is a serious political issue that no Beijing officials will agree.
It’s the will of CCP leadership at President/PM level.
Please give some valid sources, where did you get your information from? Some unknown auto executive? lol.
Oh boy! Oh boy!
I totally give up to discuss with you anymore. You just search out the informations to fit your need to bash the Chinese auto industry or draw a conclusion out of your imagination.
“GM which sold its controlling stake in Shanghai-GM to bail out Daewoo”
Please do more research before putting out such statement. GM’s move is to increase its share in Shanghai-GM-Wuling and partner with SAIC to explore the Indian market. I know the Korean auto makers are shitting in their pants when learning this. No wonder you are the most active contributor in this forum.
Interesting, the tariffs on imported auto parts are still that high? What parts need to be imported these days, aside from the engine, transmission, and PCM?
Anyways, great discussion guys.
When China was accepted to join WTO, it agreed to remove the tariffs gradually on imports of assembled auto to protect the local auto manufacturers. Yet heavy tariffs are still applied to auto parts & components to avoid the foreign partners in JV evading tax and reduce the JV to CKD assembly plants. All the big guys have already filed complaints to WTO on this issue but without success.
For those big guys like VW,GM,Toyota,Honda… they have their own (not JV) engine plants, transmission plants… in China where the JV have to place orders for the parts needed in the assembly lines. Under special pricing strategy of those auto parts, they will make a good fortune ahead of the JV. That explains to you why their products are selling at such high price in China.
Anyhow, China’s wage rise seem to be unusually stiffer than the usual this year, starting with Foxconn’s infamous 120% rise and the plan to move some of production back to Taiwan to cope with rising cost in China.
Many foreign owned exporters are planning to close their shops in China and move elsewhere due to higher cost of operation there.
Unfortunately for China, China doesn’t have enough domestic owned exporters to replace those foreign owned exporters leaving China.
Anyone who has some grasp of economics saw this coming from a mile. Wages will rise inevitably in China, same as they did in Japan and the “Tigers” (Korea, Taiwan).
About 10 years ago all China manufactured were counterfeit bags and clothes. Now as you are well aware, everything is made in China. The rise in wages will cut their profit margins, forcing companies in China to develop products with higher value added to keep profitability.
The end result will be higher quality (and higher priced) products coming out of China, and sweatshops and the like will move to other SE Asian countries or Africa.
Natural order of things.
@ Analyst
> Now as you are well aware, everything is made in China.
By foreign-owned companies or for foreign brands.
> forcing companies in China to develop products with higher value added to keep profitability.
Foreign companies will move their production base to elsewhere, and many are indeed moving to Vietnam and other SE Asian countries.
As for Chinese owned companies, good luck to them. Maybe they too need to ditch China and go SE Asia?
> The end result will be higher quality (and higher priced) products coming out of China
This requires innovation and the culture of quality on Chinese part. Exactly two points that are missing from Chinese companies.
Here is the deal.
Japanese exporters during the boom time were Japanese owned and shipping goods under Japanese brand.
Korean exporters during the boom time were Korean owned and shipping goods under Korean brand.
Taiwanese exporters during the boom time were Taiwanese owned, but shipping goods under foreign brand.
Chinese exporters aren’t Chinese owned. The majority in terms of value were foreign companies exporting out of China.
Chinese posters tend to miss this glaring differences and think it is only a matter of time before Chinese brands take over the world.
“Foxconn’s infamous 120% rise and the plan to move some of production back to Taiwan to cope with rising cost in China.” Where did you get that from? From what I’ve heard, the raise was 33%, and the reason was because of the number of suicides that happened this year, it had nothing to do with costs.
“Many foreign owned exporters are planning to close their shops in China and move elsewhere due to higher cost of operation there.”
And where did you get this from??
Ed, there were 2 rounds of pay rises within a week of each other which is a bit odd. Google “Foxconn pay rises” and you will get more info.
Exactly, it is very odd. No company would do that unless:
a.)They weren’t treating their workers fairly before.
b.) Something major happened.
Both apply to Foxconn.
From BBC news : “A string of suicides at the Foxconn plant in southern China that makes iPads and iPhones for Apple has focused attention on wages and conditions there.”
“…But the suicides at the electronics manufacturer Foxconn changed all that… “All they do is keep you busy,” he complains. “They insult you if aren’t working fast enough, or if you pause when there’s nothing to do.”
“The work is tiring,” he says, “the breaks are always late – anything from ten minutes to an hour.”
Foxconn raised its wages to try to ease the pressure on its workers, to lessen the need for them to do overtime in order to make enough take home pay.”
All a bunch of scaremongering if you ask me. Average wage means Jack S^&% in most parts of China except for statistical purposes. 5% rise in Hunan will not really be enough to entice the millions of Hunanese living in Guangdong to return home. Besides, who will drive the taxis and work in the factories if they all left?? Most Hunanren are from the countryside and work away from home because they can support their families and have a better life than working on the farm.
IF you read the original article even Morgan Stanley say its not much to worry about……
“Morgan Stanley analysts also said that despite the “seemingly large minimum wage hikes, it should not be treated as leading to broad-based wage pressures or substantial erosion of low labor cost competitiveness in China, in our view.”
The reason for this, they said, is “the magnitudes of minimum wage adjustments lag the average wage and nominal gross domestic product growth by a wide margin. The latest round of rather large minimum wage adjustment has, in part, reflected the need to make up for the no adjustment in 2009, in our view.” “.
So a few scares in 2010 and a wage rise when none were given in 2009… I don’t see queues forming with foreign companies trying to get out anytime soon.
IHC, Foxconn is one of the dodgiest foreign companies ever to operate in China. A quick Google search will provide plenty of reasons why. The only production they will move back to Taiwan is stuff that can be done by machines (which is all they have there now). It’s highly unlikely the Taiwanese workers will work 24 hour shifts making consumer goods for the western markets…. Only another Asian country would have the population base to replace Foxconns 420,000 workers and seeing the reputation Foxconn have in China they would need a pretty big carrot dangled in front of them before they allow Foxconn there in that sort of number.
@ woxihuanpijiu
If Chinese wages rise in the coast, then companies must move deep inland to find cheaper labor.
But moving inland increases the cost of shipping and shipping time, and this is why companies were hesitant to move inland in spite of incentives being waved by the communist party in the past.
For these companies that depend on low wage, it’s a lot easier and cheaper to just move to Vietnam or somewhere else than to move inland. After all, these companies aren’t Chinese and aren’t tied to China.
For companies looking at Chinese domestic market(Like foreign automakers. After all, foreign automakers aren’t in China to export.), the location of plant doesn’t matter and they will stay regardless. For exporters, it’s the time to make a decision about what their future holds.
IHC, it’s always good to talk in “if’s” but until we (the world at large) actually see it happening then it is all hearsay. Which coast (or city) are you talking about exactly? Big country….. everything isn’t made in one place. A lot of those remote places you mentioned are linked by an ever developing infrastructure and the rail service is improving rapidly and showing no signs of halting.
Goods within China usually reflect different prices based on where they were produced with some brands (automotive and otherwise) more prominent because it’s their hometown or close to it.
Some foreign automakers do export and within time it is likely the others will as well but not until they are ready or more importantly until the global economy picks up and makes it viable. Unless you are deeply involved within the management of a major auto brand then how would you know?
If the JV’s are creaming it China then why would they bother exporting when they have established manufacturing hubs elsewhere in the world that can already handle most of the demand needed?
@ woxihuanpijiu
> IHC, it’s always good to talk in “if’s” but until we (the world at large) actually see it happening then it is all hearsay. Which coast (or city) are you talking about exactly?
Guangdong, Zhejiang, Jiangsu, and Shanghai, the traditional host of foreign investments.
> Some foreign automakers do export
Those are small peanuts, usually because of production consolidation.
> If the JV’s are creaming it China then why would they bother exporting when they have established manufacturing hubs elsewhere in the world that can already handle most of the demand needed?
If it was cheaper to export cars(I am talking about fully US and EU regulation compliant cars) out of China, automakers would have done so.
But like I said it costs more to build an Accord in China than in Japan(Ditto for Camry and Sonata), so there is no auto export potential.
In fact, it is India, not China, that’s growing up to be a low-cost auto export power, thanks to its 100% foreign ownership policy and plenty of engineers.
Hmmmm, I guess the growth in Chinese exports last month must have come from the non traditional places of investment up north…
http://blogs.wsj.com/marketbeat/2010/06/10/china-offers-good-news-on-global-growth-but-concern-stays/?KEYWORDS=chinese+export+data
Then again, they don’t have your crystal ball….
Most of the cars sold in India are small so its not surprising it is exporting more low cost ones than China… but saying that they are not exporting to the US or Japan so obviously are not good enough for those markets and most of those exports are from foreign car makers anyway.
Lo-cost Indian exports are affected by fluctuating exchange rates more than the locally produced Chinese brands.
http://www.dnaindia.com/money/report_declining-euro-seen-hurting-car-exporters_1387839
The 100% ownership helps the companies keep more of the profits although saying that, 17% of Hondas profits last year were from their JV in China so no one business method seems to be better than others…. The strike and wage increases here are not a huge dent in Honda’s profits worldwide.
Like any good investment it is rational to spread your portfolio over several different investments. It worked for the US big 3 for a long time and later for the other auto makers.
” 17% of Hondas profits last year were from their JV in China so no one business method seems to be better than others….”
woxihuanpijiu, it is NOT 17% of Honda’s profits last year are from China, instead it is 17% of Honda’s total sales. Mind you the selling prices of all Hondas in China are double or even more than that in US and worldwide, can you see the rip-off and extra high profit margin in these foreign partners?
hk. My mistake, thanks for correcting me.
Not all Hondas are double the price of the US same models. The Fit is right inline with US pricing but comes with a bit less for the same price.
My factory had been notified that minimum wage will go up 22% in July. We have also received a few surveys from the local village asking us how this will effect us and if it will be a problem for us to keep operating. This is for all of Shenzhen. We have already talked to a few other factories that are talking of moving out of China on inland. Many factories have low profit margin and they can’t keep running with a large increase in wages so quickly. Wal Mart and other companies will hold them to their contracts and go to anywhere else that can meet their pricing. Not all buyers are reasonable or flexible on pricing.