Kpmg 2020 china manufacturing study 150626_vf

The 2020

Manufacturing

Footprint

of MNCs in China

- Study results -

June 2015

Michael Seitz, Andrin Lutz, Pascal Eberle

© 2015 KPMG Advisory (China) Limited, a wholly foreign owned enterprise in China, is a member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in China.

1

Content

Executive summary II

Detailed findings III

Key question and study set-up I



2

CFO

Key topics on the table

What role should manufacturing in China play in MNC’s global strategy and

which drivers influence their local manufacturing activities?

CEO COO

CRO

“Manufacturing COST in China

have been rising,

LABOR COSTS especially.”

“GOVERNMENT

REGULATIONS

“What role should China play as

a MANUFACTURING

BASE in our global strategy?” are becoming

stricter and

stricter.”

“China’s DOMESTIC

MARKET is surging.”

CHINA FOR CHINA, CHINA FOR ASIA, CHINA FOR THE WORLD?



3

Study set-up

To identify which drivers are relevant, KPMG interviewed CEOs/COOs, Supply

Chain directors and Global Sales planners

About the research design

■ In-depth qualitative interviews and quantification of

answers

■ 32 multinational companies of different industries

– Automotive, Consumer Goods, Mechanical

Engineering (evenly split-up)

– Annual revenues of USD 0.7 to 147 billion

The research process consists of three main steps

4

2

2

9

12

3 UK

USA

Japan

Germany

Switzerland

Other

Country headquarters of

companies (status quo)

Position of interviewees

(in categories)

1) Qualitative survey

■ Which drivers play a role?

2) Analysis

■ Aggregation of individual

results

3) KPMG publication

■ Published in early 2015

12

7

12

1 Supply Chain Expert

C-level executive

Director

Other



4

Drivers tree

KPMG developed a tree which depicts internal and external drivers that influence

an MNC’s manufacturing footprint

Source: Derived from Michael Porter’s National Diamond Model.

Government

■ Stability of political system

and law

■ Transparency of policies

■ Industry policies

– Localization requirements

– Ownership possibilities

– Import & export rules

– Labor laws

– Environmental protection

laws

■ Support

■ Connections

■ Regional policies

– Tax incentives

– Property lease rates

■ Enforcement of policies

Central government

Regional government

Demand conditions

■ Domestic demand

– Size

– Growth

■ Composition of market

■ Nature of buyers (values,

circumstances and taste)

■ Customer pressure

■ Non-domestic demand

– Size

– Growth

■ Distance to non-domestic

markets

■ Difference to nature of

domestic buyers (values,


Domestic demand

Non-domestic

demand

Internal factors

■ Company vision

■ Company goals

■ Ownership conditions

Company strategy

■ Organization style

■ Existing firm locations

■ Degree of localization

Company structure

Soft factors

Internal resources

■ Cash

■ Personnel

■ Planning & execution

■ Leadership

■ Perception of China

■ Willingness to change

■ Cultural exchange

External & internal drivers

Factor conditions

■ Production material

– Availability

– Cost

■ Availability of machinery

■ Land cost

Physical resources

■ Availability & cost of

transport

■ Educational institutions


utilities

– Electricity

– Gas

– Water

Infrastructure

■ Labor

– Availability

– Skills

– Cost

Human resources

Network factors

Suppliers

■ Existing suppliers

■ Distance to suppliers

■ Quality

■ Intensity of working relations

Related industries

■ Existing related industries

■ Exchange of information,

ideas and innovation

End-users

■ Existing end-users

■ Distance to end-users

■ Competitor pressure

■ First-mover advantage

■ Cost and supply advantage

■ Learning factors

■ Geographical concentration

Competitors & rivalry



5

Drivers tree

The highlighted drivers were found to be particularly relevant for survey participants

Source: Derived from Michael Porter’s National Diamond Model.

Government

■ Stability of political system

and law

■ Transparency of policies

■ Industry policies

– Localization requirements

– Ownership possibilities

– Import & export rules

– Labor laws

– Environmental protection

laws

■ Support

■ Connections

■ Regional policies

– Tax incentives

– Property lease rates

■ Enforcement of policies

Central government

Regional government

Network factors

Suppliers

■ Existing suppliers

■ Distance to suppliers

■ Quality

■ Intensity of working relations

Related industries

■ Existing related industries

■ Exchange of information,

ideas and innovation

End-users

■ Existing end-users

■ Distance to end-users

Demand conditions

■ Domestic demand

– Size

– Growth

■ Composition of market

■ Nature of buyers (values,


■ Customer pressure

■ Non-domestic demand

– Size

– Growth

■ Distance to non-domestic

markets

■ Difference to nature of

domestic buyers (values,


Domestic demand

Non-domestic

demand

Internal factors

■ Company vision

■ Company goals

■ Ownership conditions

Company strategy

■ Organization style

■ Existing firm locations

■ Degree of localization

Company structure

■ Competitor pressure

■ First-mover advantage

■ Cost and supply advantage

■ Learning factors

■ Geographical concentration

Competitors & rivalry Soft factors

Internal resources

■ Cash

■ Personnel

■ Planning & execution

■ Leadership

■ Perception of China

■ Willingness to change

■ Cultural exchange

External & internal drivers

Factor conditions

■ Production material

– Availability

– Cost

■ Availability of machinery

■ Land cost

Physical resources


transport

■ Educational institutions


utilities

– Electricity

– Gas

– Water

Infrastructure

■ Labor

– Availability

– Skills

– Cost

Human resources

moderate importance high importance Legend:



6

Content






7

Millions

Summary of findings

Top-4 issues mentioned by survey participants which influence the manufacturing

activities of MNCs

28%

Labor acquisition and

retention 22% 66% 13%

13%

Rising labor cost 13% 59%

Agree Disagree Did not mention

47%

Stricter government

policies and enforcement

56%

41%

Inadequate

supplier quality 41%

44%

2

1

3

4

16%



8

Summary of findings

Despite a rising cost base, MNCs continue to manufacture locally to serve the

domestic market, and this is not likely to change in the medium term

■ Most MNCs are now focusing their operations “in China for China” in order to better serve the domestic market,

and this focus is not expected to change through the medium term

■ Manufacturing operations established “in China for the World” are becoming less attractive due to rising

production and energy costs in China

■ There are three key reasons that have caused the cost base of manufacturing MNCs to rise:

(1) Increasing labor costs, supplemented with labor acquisition and retention challenges

(2) Stricter government regulations related to labor legislation and environmental protection and their enforcement

(3) Inadequate supplier quality which impacts the quality of product components

■ Yet China will remain the preferred manufacturing location for MNCs to serve the domestic market due to:

(1) Companies’ existing operations

(2) Proximity to local customers (present and future growth)

(3) Established supply chain clusters and networks

(4) High-quality infrastructure



9

Summary of findings

To succeed in the Chinese market, MNCs should focus on the following derived

factors, which determine to what extend drivers will act on them

Encouraging and discouraging drivers



10

Summary of findings


factors, which determine to what extend drivers will act on them

■ The drivers mentioned above are connected to the following moderating and amplifying factors that determine to what degree

MNCs are incentivized to keep or move their production in China.

(1) Government-related drivers: Stricter government policies are moderated by the match with the industry policy, degree of

environmental cleanness and intensity and quality of relationships with officials of the respective MNC

(2) Network-related drivers:

Inadequate supplier quality issues are moderated by a strong control over suppliers;

Moreover, established supply chain clusters and networks are amplified by the respective level of maturity

(3) Demand-related drivers:

The importance of domestic demand is amplified by the importance of China for the respective MNC;

Furthermore, customer proximity is amplified by the service intensity as part of the respective MNC’s value proposition as

well as the importance of delivery speed, and moderated by an increased product value density

(4) Factor conditions-related drivers:

Rising labor cost is amplified by the degree of manual labor within the value creation of the respective MNC and

moderated by a higher value added of products as well as employer brand popularity;

Existing infrastructure is amplified by a higher dependency on existing infrastructure of the respective MNC

(5) Internal drivers:

Company’s existing locations are amplified by the complexity of the existing company network of the respective MNC



11

Summary of findings

Six strategic directions should lie at the core of MNCs’ growth strategies in China

■ We see that there are six strategic directions emerging to render MNCs competitive in China

(1) Commit and localize: Ensure there is a committed headquarters with a localized Chinese country organization

(2) Speed: Increase the efficiency of production activities in China

(3) Upgrade: Invest to move towards higher value-add production activities and services

(4) Acquire and retain: Formulate a China-specific HR strategy

(5) Anticipate: Seek opportunities arising from changes of government regulations, particularly in areas of product

safety and sustainability

(6) Educate: Develop suppliers to a level that satisfies quality, cost and performance requirements



12

Content






13

China’s role

MNCs’ focus has shifted from considering China “the factory for the world” to

producing “in China for China”

“For the whole automotive industry, China is the number one

market, and this is the case from OEMs down to tier-3 suppliers“ Director of Production, automotive company

Millions

In China to serve

the domestic market

Agree Disagree

94% 6%

■ 30 out of 32 participants said that their company was in China with the goal of serving the domestic demand and

that this will remain the case in the midterm future

“Until 2003, the capacity in our factory in Suzhou was not fully

utilized and we exported around 30% of our products to other

Asian countries. In the following years, we witnessed a steep rise

in domestic demand, which led to a full utilization of our factory.

Domestic sales increasingly replaced exports” Director, consumer goods company

■ Export production is negligible for most of the survey participants when asked about their China operations

■ The size and recent growth of the Chinese market leaves little room to concentrate on non-domestic demand

“Our electronics division started manufacturing operations in

China to profit from cheap factor costs for export markets.

However, the domestic demand became so strong from 2004

onwards that we shifted our focus inland“ Assistant to the CEO, automotive company



14

Three main reasons for rising production costs (1/3)

Increasing labor cost, supplemented with labor acquisition and retention challenges,

have been a major issue of concern for MNCs

Millions

Increasing salaries as well as

labor acquisition and retention

issues are important cost

drivers

Agree Disagree

56% 16% 28%

Did not mention

“Especially for technologically complex products, China is no low-

cost labor location anymore. Total labor cost increased driven by

government regulation, trade unions, social insurance and many

other factors” Director of Production, automotive company

■ Salaries for qualified employees (e.g. experienced and English-speaking factory managers or engineers) has

reached a level that is comparable to or in some cases even above that of developed countries in the West

“We find it extremely hard to find skilled employees such as

engineers, quality managers, technical personnel or administrative

directors” Supply Chain Head, consumer goods company

■ Finding and retaining skilled workforce (in particular, experienced and English-speaking technical personnel) is a

top-issue for MNCs, driving labor cost

“In the major clusters, there is a strong war for talent. It is

challenging to keep our workforce. Employee turnover can be

15-20% across all levels per year. China President, automotive company



15


Stricter government regulations as well as their enforcement aim at protecting factory

workers and the environment and at creating a greater value added

Millions

Stricter government

regulations are driving cost

Agree Disagree

44% 41% 16%

Did not mention

“The cost of pension funds and social insurance are high in China

compared to other Southeast-Asian countries and create an

important overhead on labor cost” COO, consumer goods company

■ Labor legislation and enforcement has become more rigid; they cover areas such as social benefits, overtime

work, workplace safety and other labor protection measures

“The environmental standards for building a new factory are higher

in China than in Germany” Supply Chain Manager, mechanical engineering company

■ New Environmental protection policies set stricter standards in regard to wastewater treatment, air pollution, noise

and scent emissions

“We had to upgrade our facilities to the new security standards.

There are detailed guidelines for everything – from the type of

protection gloves to number of fire extinguishers” Supply Chain Manager, mechanical engineering company

“The Shanghai government doesn’t want to have heavy industry in its region

anymore, it wants biotech companies, R&D, service firms and banking” General Manager, mechanical engineering company

■ Local governments follow their own agenda in supporting certain industries; heavy manufacturing and non-high-

tech companies are urged to move westwards



16

Millions


Inadequate supplier quality, which results in high costs associated with incoming

goods inspection, continues being a concern for MNCs

Inadequate supplier quality

is a cost driver

Agree

47% 41%

Did not mention

“We often have quality issues. For instance, the isolation material of

a supplied product was supposed to be black but the supplier ran

out of stock. Instead he took grey isolation material and painted it

black. This impacted the conducting properties of the product and

we could not use it anymore” General Manager, mechanical engineering company

■ Supplier quality is an important cost driver for MNCs in China, since the lack of reliability of supplied parts often

creates unpredicted cost during the production process

“With suppliers, we often have issues regarding quality control,

quality management, as well as compliance with ethical, legal and

environmental standards” APAC COO, consumer goods company

■ The supply quality issues result in intense working relations with suppliers to teach them and ensure consistent

quality, more frequent quality controls and supplier audits

“Suppliers in China require intense management and monitoring.

We visit our suppliers around four times a year” APAC Managing Director, consumer goods company

“The cost to keep supply quality on the level is very high. We have

to check 100% of all incoming die casting parts, and although they

were quality approved by our supplier, we still reject 20% of every

delivery” General Manager, mechanical engineering company

Disagree

13%



17

In China for China

There are four reasons why China will remain the preferred manufacturing location for

MNCs to serve the domestic market

“Most companies expand at their existing location because with every relocation, you have to build up a great deal of knowledge about

local conditions. For us in particular, knowing the import procedures and regulations in Shanghai was a main reason to stay here” Sales Director North Asia, consumer goods company

94% 6%

(1) Companies’ existing operations: Typically, companies try to expand or settle new businesses at existing

premises, since they can profit from existing location-based know-how

“As a supplier, we have to stay close to our customers.

If OEMs go inland, we follow” China CEO, automotive company

(2) Given the large number of existing and potential customers, the proximity to customers is important in

China. Furthermore, it allows for a decrease in lead-time, a reduction of transport cost, and it promotes a better

understanding of the customer

“Closeness to customers is definitely important in order to avoid

high delivery times and logistics cost” General Manager, mechanical engineering company

“Our factory in Thailand imports 75% of all components from

China-based suppliers. From a procurement point of view, moving

out of China would not make sense” Vice President, mechanical engineering company

(3) China offers unparalleled supply chain clusters and networks. This significantly reduces transaction costs, but

it spurs competitiveness – innovativeness, speed and quality of service delivered will be a key competitive

advantage in the future “The local supply chain was patchy in the past, but in the past five

or six years many related industries have settled in China.

Nowadays, China is the sourcing center of the world” China President, automotive company

“Everyone is here, from MNCs to local competitors, China has the highest population density in this industry worldwide” Director of Production, automotive company

(4) The level of Infrastructure in China is very high and comparable to or at times even better than in developed

countries. Particularly the improvement of land-based logistics (road and rail), the establishment of multi-modal

facilities as well as China’s highly efficient ports and air terminals were mentioned as key advantages

“China is by far the country with the best infrastructure in Southeast Asia.

India, for example, is extremely weak in this regard” China President, automotive company

“China has a state-of-the-art transportation infrastructure” Supply Chain Head, consumer goods company



18

Key variables


variables, which determine to what extend drivers will act on them

Encouraging and discouraging drivers



19

Recommendations (1/2)

We see that there are six strategic directions emerging to render MNCs competitive in

China

“Our China operations are the only regionally organized units in our company. This allows us to

quickly react to market developments, which is essential in such a fast-paced environment” Vice President, mechanical engineering company

(1) Commit and localize: Ensure there is a committed headquarters with a localized Chinese country organization.

A relatively high degree of independence from the headquarters is important to keep up with the speed of the

Chinese market

“Workforce efficiency can still be increased – take internal logistics as an example: There is an army of

people moving things around in the factory without creating any value. By optimizing the flow of goods, a lot

of man hours can be saved” Vice President Supply Chain North Asia, consumer goods company

(2) Speed: Increase the efficiency of production activities in China to counter higher labor cost

“We have to increase productivity per headcount and achieve a higher value added through

the development of new product generations to counterbalance the rising labor cost” China CEO, automotive supplier

(3) Upgrade: Invest to move towards higher value-add production activities and services, thereby lessening the

dependence on low-cost



20

Recommendations (2/2)

We see that there are six strategic directions emerging to render MNCs competitive in

China

“We managed to achieve a high retention amongst our employees through

fair and transparent compensation, a flat hierarchy and a participative mentality” APAC COO, consumer goods company

(4) Acquire and retain: Formulate a China-specific HR strategy by transparently informing about salary growth,

installing retaining bonuses and offering career development perspectives to employees

“There is a lot of pressure from legislators to enhance product safety. Traceability, accountability and

transparency of supply chains are equally important. We have to be able to prove where each ingredient comes

from. We also try to incorporate this into our brand in order to build a trustable relationship with our consumers”

Director, consumer goods company

(5) Anticipate: Seek opportunities arising from changes of government regulations

“We have established a partnership program with our suppliers to increase quality and operational excellence. We regularly

identify challenging suppliers, and together with them we analyze their process, identify issues and work on solutions” Supply Chain Head, consumer goods company

(6) Educate: Develop suppliers to meet quality, cost and performance requirements

Contact

information

Michael Seitz

Senior Manager,

Head of Procurement Advisory

[email protected]

+86 21 2212 4057 +86 156 1862 3085

© 2015 KPMG Advisory (China) Limited, a wholly foreign owned

enterprise in China and a member firm of the KPMG network of

independent member firms affiliated with KPMG International

Cooperative ("KPMG International"), a Swiss entity. All rights reserved.

Printed in China.

The KPMG name, logo and ‘cutting through complexity’ are registered

trademarks or trademarks of KPMG International Cooperative (KPMG

International).

T:

M:

Andrin Lutz

Head of PQM ASPAC,

Global Center of Excellence for

Procurement Advisory

[email protected]

+86 21 2212 3393 +86 185 2150 0155

T:

M:

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