Many companies have decided to transfer production to China based on a difference in unit product price. But they haven’t thought of a full business model.
In this article we go over the basics of what should be included in the business model if you are thinking of outsourcing manufacturing to China. This is not a definitive list and we have not touched on the legal aspects such as manufacturing agreements and contracts — these are topics for a separate article.
1. What are the main reasons for outsourcing manufacturing to China?
1.1 Labor Costs
As part of your outsourcing decision making process you should be looking at the internal cost of labor. One of the biggest costs in any manufacturing company is the cost of labor. This is not just the cost of paying the workers’ salaries — it also includes their additional costs of health care benefits. And, if serious engineering work is required for new product developments, it also includes the engineers’ salaries.
1.2 Material Costs
Some commodities such as oil or aluminum are traded at roughly the same price anywhere in the world. But significant savings can be made if certain materials, such as synthetic fabric rolls, are purchased in China.
1.3 Overhead Costs
The reduction in overheads from running an operation between Western companies and Chinese companies includes the benefits of cheaper utilities such as gas, electricity and water as well the overall running cost of an operation.
Outsourcing manufacturing to a contract manufacturer often means being able to take advantage of increased capability over what a company has in-house. A contract manufacturer in China would have a more diverse set of machinery and equipment as they would have to cater for manufacturing different products in a variety of industry niches.
1.5 Overall Product Cost Reduction
The culmination of all the above benefits results in products being manufactured for less than what is achievable in most Western manufacturing operations. This alone may be a reason to outsource manufacturing to China. However, before any business decisions are made to outsource, there should be a full business model structure in place that takes into consideration all the elements required to manage outsourced manufacturing.
ISO 9001 as quality system in China does not carry the same weight as it does in the West. If a Chinese factory states it is ISO 9001 certified, this could literally mean that they have purchased a set of documents, paid an auditor to come and have tea, and in the end they have a certificate that it hangs on the wall for everyone to see.
The better approach when outsourcing manufacturing to China is to set up your own quality system for the contract manufacturer to follow. That does not mean set up your ISO style system, but rather having a clear set of quality criteria and instructions that the manufacturer has to follow (ensuring clear work instructions are in place, providing them with a ‘master sample’ and samples that are ‘not acceptable’, etc.)
Whatever system you have in place, one of the key actions has to be checking goods before they leave the factory. As you do not have the ability to walk down the production line any time you like due to the fact you have now transferred production to China, you should make provisions for the next best thing. Contracting an independent inspection company can be your eyes in China while you are not there, they can inspect products during the production phase, they can carry out the final random inspection once all the goods have been completed and provide you with full detailed reports of the actual situation. More info about this here.
One element to take into consideration when constructing your outsourcing business model is transportation. This may sound obvious but there are often hidden or forgotten costs associated with transportation of goods from the factory in China to the desired location of your distribution point, wherever that may be.
You need to understand at which point you take responsibility for the transportation of your goods. Is it once the product leaves the factory, known as Ex-Works (EXW), or is it at the point where the product is classed as Free on Board (FOB), meaning the seller delivers the goods on board the vessel nominated by you at the named port of shipment? I strongly advise to buy FOB.
The sometimes forgotten costs or fees come from the clearance documentation required to clear customs in China, the import duty and tax due upon arrival in your country and then potentially the biggest forgotten cost is the land transportation to your distribution point from the port of arrival.
Note that a CIF arrangement is often a way for a supplier to make extra money at the importer’s expense… as described here.
Make sure you have a clear understanding of these elements within your manufacturing outsourcing business model. Different types of shipping methods from China should also be modelled (do you ship a certain quantity by air, what is the door to door delivery time when switching between air express and economy air, what are the logical quantities for your product when it comes to air shipment…?).
Maybe your product is just too large or too heavy and just wouldn’t make sense to send via air unless the timescales demanded it and the benefits of an early delivery outweigh the cost of air shipments. When considering sea freight, plan delivery schedules and look at the product demand to ensure you do not run out of inventory while product is being manufactured and shipped (shipping times can be up to 6 weeks depending on where you get products shipped to).
4. Fulfilment (distribution network)
Whatever your fulfillment method or distribution channel network, you need to ensure product is available when it is required. This will tie directly into your schedule planning and the transportation and logistics element of the business model.
You also need to plan with your contract manufacturer in China the packaging methods and labeling as different point of sale requirements may be apply to different distributors. For example, Amazon would impose certain labeling requirements and would be less strict regarding the way a product is packaged, whereas some of the leading brick & mortar retailers may be more focused on how the products can be stored and presented within their stores and point of sale racking systems.
5. Customer Support
Having a customer support team in place is important with every product and every company so that all questions, issues that customers have, and warranty claims can be addressed promptly and personally. Being able to interact with your customers once they have made a purchase inevitably has a positive impact on business, from the auto responder emails series that you send out once a product is purchased (this is more appropriate for products sold from ecommerce sales platforms) to being able to discuss customer complaints and resolve problems they may have, and generally just being able to help them out when needed.
6. Production follow up
Having your products manufactured in China just means that you need to keep on top of any production changes that are implemented just as you would if you were still making products in your local plant. The location may have changed but the process is the same. And generally it takes much more time to do the daily follow up on production issues with a Chinese supplier. Best practice is to apply a project management approach.
Just make sure your customer service team is kept up to date on all communications and are well educated and informed about all products regardless of where they are produced geographically.
7. Marketing Budget
The marketing budget is naturally part of all business models and should not be affected by the production location. Marketing affects most areas within your business.
The allure of low cost production in China is very appealing to many companies but as we have seen, it is not just the cost of the product that needs to be taken into consideration when planning to outsource manufacturing to China.
Constructing a carefully thought-out business model that takes into account all the additional costs associated with each of the elements above will allow individual organizations to calculate the true benefit of transferring or outsourcing manufacturing to China.
The important point here is to make sure you get a full business model in place and that each of the basic elements are understood before pulling the trigger on ‘going to China’.