31 July 2008

China's low-ball pricing

By Jim Pinto

In recent years, manufacturing in China has been growing so quickly the country’s total output will exceed that of the U.S. manufacturing sector in the near future. The country with the world’s largest population is set to become an even more powerful force in global production.

Prices for Chinese manufactured goods are typically half of comparable U.S. and European products, and this continues to give China a strong competitive advantage, causing financial and manufacturing resource shifts. However, here is something most people do not realize: It is not low-cost labor; it is low-ball pricing. China simply accepts much lower profit margins.

U.S. businesses typically target 50% gross profit margins and 10-15% net profit. Developing countries (other than China) look for 30-35% gross-profit, or 5-10% net-profit. China accepts gross-profit margins of about 5%, with 2% net-profit—or even zero profit sometimes. Therefore, even with comparable manufacturing costs, Chinese products are the cheapest.

Here is a simple example to illustrate the point: Let’s say a product costs $40 to manufacture. In the U.S., the target selling price will be $80; in other countries, typically $60. The Chinese would sell that product for just $42, maybe even $40 (zero margin). This astounds most outside observers—how can a profit making enterprise survive (capital and cash flow) with no profit?

The answer: In China, short- and medium-term operating deficits are acceptable since the government manipulates and controls capital. Chinese planners recognize the demand for short-term profit in Capitalist countries. Their own primary strategic objective is long-term global market share. The tactics are: high volume; fast response; immediate local employment; and high investment in automation and quality to maintain price leadership.

Another key point: China mandates disclosure of all intellectual property, demonstrating yet again their long-term perspectives. The Chinese see this as a priority, which will help them attain long-term technology and market leadership goals. By contrast, foreign outsourcers are giving away knowledge and intellectual property for short-term financial gain. The results are evident in China’s ongoing economic transformation.

For America, the remedies require significant attitude shifts. Our short-term financial mind-set must change. Business needs to realize continual quarter-to-quarter increases in revenue and profits cannot continue on and on with work done elsewhere in the world.

Manufacturing and job creation are not just political or business manipulations, but the building blocks of society. It is important for us to keep investing in jobs, to upgrade factories. Entrepreneurship and talent must be encouraged and stimulated to thrive in the manufacturing sector.

Whoever makes things better, cheaper, and faster wins. America must continue to be the leader or slide backward into mediocrity.

Related links:

• InTech (April 08) – China targets the Achilles’ heel of Capitalism:
  www.isa.org/link/ChinaAchilles
• Business Week - “The China Price”:
  http://www.businessweek.com/magazine/content/04_49/b3911401.htm
• Wal-Mart’s ‘China Price’:
  http://www.alternet.org/workplace/27829

Behind the byline

Jim Pinto is an industry analyst and founder of Action Instruments. You can e-mail him at jim@jimpinto.com or view his writings at www.JimPinto.com. Read the Table of Contents of his book, Pinto’s Points, at www.jimpinto.com/writings/points.html.