Last week I described a few ways Chinese manufacturers differentiate their products, based on an article from Global Sources.

Now let’s have a look at how they cut their operating costs. It is pretty ugly, as described by professor O’Connor:

Dr. Neale O’Connor from the University of Hong Kong conducted interviews with over 600 Chinese suppliers and he found: in spite of numerous different challenges such as HR issues, competition and achieving sales targets, many suppliers view the pressure to control costs as the most difficult to get to grips with. Furthermore, in many cases foreign customers are the source of this pressure piling. Dr. O’Connor comments on the feedback from his interviews: “Suppliers respond to these pressures in several ways – they may try to be more efficient by streamlining internal operations, but lack the knowledge and expertise to do so. More alarmingly, a significant portion seek to alter their management of inputs, in particular sub-contracting their work and buying cheaper materials.”

This sounds very true to me. Most manufacturers in China are not trying to work smarter, so the only way to reduce costs is to cut corners.

Substituting cheaper materials (either thinner or of lower grade) and placing production in a cheap factory (usually a small workshop with no quality control whatsoever) are very common ways of reducing costs.

In reaction to being squeezed by their customers, Chinese suppliers resort to such cost-saving measures and end up passing on their work to sub-suppliers whom the customer has no control over and may not even be aware of. The ‘sub-suppliers’ themselves are also being squeezed; they in turn will also resort to sub-contracting and using lower-quality materials. This negative knock-on effect results in a “sub-supply chain” where product quality is comprised at each level. In the end it is the customer who suffers most by receiving bad product, coupled with a breakdown in the relationship.

Again, very true. Putting pressure on a supplier to decrease prices is often a recipe for diaster. If the manufacturer only makes a 2% net margin on your products, you are pushing him to cut corners.

Then O’Connor proposes two ways importers can avoid these situations:

• Monitoring production closely
• Investing in supplier development (i.e. improving the factory’s processes and general organization), which allows the buyer to enjoy lower costs and a stronger relationship with his supplier.

(Source: The China Supplier 1000 Project, from Fiducia‘s excellent newsletter).

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Bonus: for those of you who can access Youtube, here is a video by O’Connor about Chinese suppliers’ challenges: