The world’s largest corporations have poured billions of dollars — and virtually every other type of currency — into China in pursuit of two basic objectives: First, to use the nation’s low-cost labor to make and export relatively inexpensive products to markets around the world, and second, to build manufacturing, sales, and distribution networks that can feed China’s hungry market of 1.3 billion people.

But many companies have generally pursued these twin aims without any real attempt to marry the two operations and harness manufacturing efficiency and economies of scale. In a rush to exploit China’s seemingly endless market potential, companies have neglected to import the best ideas from their operations elsewhere in the world or to develop new ones in China — and as a result they are missing out on opportunities to create additional value for their shareholders.

That is one intriguing conclusion from a recent study conducted by the American Chamber of Commerce (AmCham) in Shanghai and Booz Allen Hamilton. This study, “China Manufacturing Competitiveness 2007–2008,” surveyed 66 manufacturers in such industries as consumer, industrial, health care, and materials. Eighty-one percent were wholly owned by foreigners and 10 percent were joint ventures between multinationals and Chinese partners; 9 percent of the respondents chose to identify themselves as “other.” About one-third of the respondents had an additional major presence in China beyond their manufacturing footprints: More than 50 percent had representative offices and roughly one-third had regional or global headquarters in China. The study found that three out of four companies lack fundamental best practices in their China operations and more than half — 57 percent — have failed to integrate the dual functions of export platforms and operations that support production for the domestic market.

This is particularly problematic because the economic fundamentals in China are shifting rapidly. China’s fortunes are rising as it continues to attract capital investment externally and internally in high-tech industries such as aerospace, electronics, biotechnology, and environmental and alternative energy technologies. This means, however, that it is losing its long-standing status as a premier source of an abundant, cheap labor force that companies could count on to consistently deliver big returns. Indeed, China’s operating environment is becoming more expensive as costs increase and the currency strengthens, a fact lost on few manufacturers. More than half of the surveyed companies — 54 percent — agreed with the statement that “China is losing its competitiveness to other low-cost countries in manufacturing.” One of every two respondents said that India, Thailand, and Vietnam are challenging China’s low-cost position. Nearly one in five (17 percent) have already made the decision to move at least some China-based operations to other low-cost countries. Other organizations have produced similar findings. The Federation of Hong Kong Industries estimates that 10 percent of the 60,000 to 70,000 Hong Kong–owned factories in the Pearl River Delta region (broadly defined as Guangdong province, Hong Kong, and Macao) will be shuttered this year because of costs, likely the highest closure rate in 20 years.

Companies can avoid falling victim to China’s shifting economic realities — and benefit from the nation’s large and productive labor pool and its vast market of consumers — by becoming what we call global supply chain integrators. This involves linking factories, materials purchasing, and sales operations into a tightly knit unit. China should be seen as part of an international web of capabilities, including manufacturing, innovation, new business models, logistics, and talent development. In making China a critical component of their global operations, rather than just another satellite market, companies can create a global strategy that leverages China’s size and dynamism.

Indeed, according to the AmCham/Booz Allen survey, companies that have successfully integrated their Chinese export-oriented activities with their Chinese market operations are achieving higher levels of profitability: They report gross profit margins of 29.6 percent compared with 17.9 percent for those that have not achieved integration. 

Integrated from the Ground Up
Developing the mind-set that global integration is imperative is the starting point for companies in becoming a global supply chain integrator. In putting global integration into practice, one key step is to create manufacturing systems that produce large volumes of products but delay the moment at which those products have to be customized for specific Chinese and non-Chinese markets. There may be an infinite number of ways to assemble a personal computer, for example, but few of those ways make economic sense until and unless the company knows who the final customer is. This concept is called postponement, and, of course, there are different ways of achieving it depending on the type of product being manufactured. Hewlett-Packard Company engages in light postponement, making universal printers with the same labeling and packaging for all orders but including power supplies and language-specific manuals at the last moment. Motorola Inc. engages in more advanced postponement for its radio products by waiting until specific orders are received and then adding customized labeling and packaging.

Companies that are successful at postponement also typically create what we call tailored business streams. These companies take advantage of China’s capacity for large-scale, cost-efficient manufacturing yet retain high levels of differentiation throughout the assembly process for both Chinese and global markets. At their heart, tailored business streams segregate the manufacturing of products with similar needs into parallel tracks. A PC manufacturer such as Dell Inc., for instance, identifies the common elements that unite 80 percent of its output, while reserving 15 percent of capacity for somewhat predictable demand conditions and 5 percent for opportunities that simply cannot be forecast.