Is moving inland really cheaper?

Originally I was asked to write on the advantages of east-coast China vs. western-interior China manufacturing capabilities. However, because there are so many different industries it quickly became obvious that I couldn't do the specifics justice. If you're new to China and you want to know generally where to go, check out this quick and simple post on The China Sourcing Blog about some regional generalities and strengths: http://www.chinasourcingblog.org/. For a more in-depth look at the specifics of many Chinese provinces, the blog "All Roads Lead to China" (www.allroadsleadtochina) did some great province-by-province comparisons a year or two ago. The originals are a bit outdated, but the blog regularly updates individual cities and industries and is a great source of information on China in general.

What I present here are not city-by-city or province-by-province advantages and specifics, but rather some general guidelines as to how to make the decision as to where to locate. Do you want or need to be in China's first-tier cities or is a second-tier city better suited for your needs?

The first tier: cities you already know

Beijing and Shanghai are always listed as first-tier cities. Sometimes Guangzhou and/or Shenzhen are included in the lists. I'm not sure why these two Pearl River Delta cities are not always included. If lists are made by income, Shenzhen has the highest per capita income in China, the first Chinese stock exchange and was the first special economic zone in the country. Factory wages are as high, if not higher, in the Pearl River Delta than just about anywhere else in the country. If first tier cities are determined by developed services or infrastructure, the Pearl River Delta has great expressways, the busiest airports (plural) and growing subway systems. Shenzhen not only has its own international airport, but is at least as close to the HK international airport as downtown Shanghai is to the new Pudong International Airport. Guangzhou has a relatively new international airport and both Guangzhou and Hong Kong have a collection of foreign consulates that Shanghai does not. There are also abundant international legal and professional services, world-famous tradeshows and golf courses, and myriad international schools in each city. Looking at population, Shenzhen officially passed 10 million in 2006 and Guangzhou is closer to 13 million-certainly not as big as Shanghai's 18 million, but comparable to Beijing's 12 (and none are as big as Chongqing at 32 million).

The deciding factory may be that there are not as many Italian restaurants in either Guangzhou or Shenzhen as in Shanghai (but there certainly are more than in Beijing, so I'm still not sure why these cities don't make the grade!) Whatever the reasoning for others, I'm including Shenzhen and Guangzhou here as first tier-as far as I'm concerned, the Pearl River Delta from Hong Kong to Guangzhou is just one gigantic first-tier city/industrial zone. Most export-oriented business people that come to China are already coming to this region for tradeshows and/or factory visits. The annual (ex)port traffic from this area is more than double the annual numbers from the Yangzi River Delta (Shanghai, Zhijiang, Jiangsu), the second-largest production location in the country.

The second tier: cities you might recognize

So, now that those four cities are out of the way, what exactly is a second-tier city? This again depends on who is making the list; some lists go by population, some by income, some by location, some by political campaign and some by the Chinese government's amount of federal investment. I may not be able to define it exactly, but, like the old adage, "I know em when I see em." Chengdu, Chongqing, Dalian, Huizhou, Nanjing, Ningbo, Qingdao, Shijiazhang, Shuzhou, Wuxi, Yiwu, Xi'an, Xiamen and Zhuhai are all second-tier cities that I've either visited or worked in at least a couple of times in the last 5 years. Haikou, Harbin, Kunming, Tianjin and Wuhan are others that I've only visited once, but not yet worked in. So I'll describe the differences between these first and second-tier cities from my own manufacturing and sourcing experiences.

* Important note: I use the terms "east" and "west" synonymously with "first tier" and "second tier," respectively. Why? Despite the fact that Xiamen and Qingdao are about as east as you can possibly get in China without going to Taiwan, all of the first-tier cities are considered to be in the east of China and most of the second-tier cities (as well as the money and the political campaigns) are farther west.

OK, sorry to slow you down. Back to the story!

To move or not to move...

Making the decision to move to a second-tier city requires the same kind of forethought as your original decision to move to China. And the first questions that you need to ask yourself concern the financial viability of moving anywhere.

Why are you moving? Really, honestly, why are you considering moving to another province? Is it because you've confirmed lower prices? Is it because you've heard that prices are better elsewhere? Is a competitor in your industry suddenly doing things that are making you wonder? Are factories and industry resources moving and you need to be keeping up? Is it the popular thing to be talking about?

Reasons to move should NOT include any version of "because we heard it's cheaper" or "because others are doing it." Before you say, "Duh, I'd never do that," you need to be honest with yourself. Have you done your homework and is it really cheaper? We have had multiple requests in the last year from people asking me if I include Vietnamese factories in the sourcing and information that we provide. We often do, but I always ask "why?" in response. And without exception, the answer has been some version of, "Because we heard that it's so much cheaper there." These aren't just new buyers asking for this either. Two of these requests came from MNC's-companies that are buying/producing hundreds of millions a year. No research, no numbers, just hearsay. Media "buzz."

There are legitimate reasons for moving, of course. And price might be the decision-maker for you. But you need to confirm all the numbers first. Other legitimate reasons include, for example, industry relocations, specific tax advantages in newly developed special industrial zones, or new legal, labor or environmental restrictions/advantages.

Because of the new labor law in China, many factories-and some entire industries-are leaving the East, and even China as a whole, due to increased prices and restrictions on labor. Thousands of factories have closed down in Guangdong province alone and some industries now have (or soon will have) a larger presence in Vietnam or Thailand than they had in China just a year or two ago. But not every industry nor every factory is moving.

EASTERN CHINA

What are the costs and benefits of not moving? Before deciding that moving is the best option for you, look at all the developed areas of eastern China and measure the costs and benefits so you can see if moving is really worth it.

Supply chains and logistical services. Probably the single largest (and most underestimated) benefit of staying in the East is access to developed supply chains and advanced logistical services. You really can't place a value on having a developed and tried supply chain. It doesn't show up in expense reports and, outside of trucking fees, it can be overlooked pretty easily to justify a move to a "cheaper" location. But it can make or break production deadlines and can be either a huge hidden asset or a huge hidden cost.

Two years ago we produced some canvas items for a client. The factory locations that we finally chose between for the contract were in Ningbo and Cambodia. Because of location, neither was our first choice, but both had the products, the quality and the price that we wanted. Unfortunately neither of the factory locations had a well-developed supply chain nor good logistical support. It was actually just as fast to get from Shenzhen to the Cambodian factory as it was to get to the Ningbo factory.

(Side-note: the truth about Chinese factory addresses and airports-yes the name on the card said Ningbo, but the factory was hours out into the mountainous hillside. Similarly, no airport is actually in the city it's named after. Not one. Plan on at least a 45-minute taxi ride into downtown no matter where you are flying into.)

We don't have difficulties in supply chain or logistics in Shenzhen, but we don't have the canvas factories either. We had to ship canvas from Ningbo back to Guangdong province (or from Cambodia to Thailand) to finish packaging and complete the orders. The lesson here is that when you go west, unless the entire product and all the component parts can be made in the second tier-city, you're going to be shipping to and from multiple locations, often through less-than-ideal transportation networks.

Employee quality. Another benefit of the East Coast is the quality of the potential employee pool (at the expense of the second-tier cities, not doubt). You get the best of the best on the East Coast because of the draws of city life and the potential for higher earnings. While you certainly can find and train quality people elsewhere, you can't discount the value of a large group of people that already have education, experience and some language skills in one location. Certainly this is changing as more and more opportunities open up in the second tier cities, but by and large first tier cities stil draw the best and brightest.

(Another side-note here. Some of the best employees that we've ever had were interns from US colleges and universities that were Chinese and/or business majors. The best Chinese employees we've had were people that were looking for expanding opportunities and came from completely different industries in Shenzhen. The lesson is: don't discount the draw of a big city on educated, experienced, motivated employees.)

Physical resources. A third advantage is the availability of physical resources in the cities. Airports (as opposed to air strips with a Chinese restaurant and a luggage belt), ports, embassies, legal services, 3PQ and 3PL offices, testing and inspection offices, notary republics, rental car agencies, regional and provincial governmental offices and some western creature comforts and hospitals. If you're doing business the right way, convenient access to these types of services is mandatory.

It goes without saying that distance to ports (both air and sea) is a distinct advantage. Each of the east-coast cities and special economic zones has their own ports that can typically be accessed within an hour or two, instead of a day or more. We work with a number of suppliers in Anhui province and always have difficulties with being on time because of delays in to-port delivery. Not only is there a larger opportunity for things to go wrong with questionable roads and winter storms, but there are inter-provincial licenses and permits that must be purchased for some items.

Another experience. Let me first say this, China's national toll-way system is actually very good. But trucking companies and factories don't like to use it because of the tolls and checkpoints. Furthermore, many of the access roads and local highways that connect to the national toll-way system are horrible! When we ship domestically we require the logistics providers to use the toll roads. We once shipped a container-load of glass bottles from one city to Dongguan, near Shenzhen. Almost the entire load showed up broken. Why? Because the factory that made the bottles refused to pay for the 3PL to use the expressway (unwittingly opting instead to pay for an entire container-load of replacement product).

Furthermore, suppliers that are not in close proximity to first-tier cities often don't have the access to complementary resources that are available en masse in the first-tier cities. As I pointed out before, just getting the major product cheaply is not enough-you've got to add in all the packaging, testing, printing, logistics, etc.

We often do work in Xiamen and have found that some of the facilities there are honestly world-class. The city is quite nice and the availability of professional services and other logistical supports is really quite good. But we can't get everything we need there and so we are always shipping things to or from Xiamen-adding time and expense to every project that we do there. So why do we continue to work there? Because we have a well-developed supply chain in Guangdong Province that can support our work in Xiamen. The lower prices in Xiaman are still a good value for us because we've got everything worked out to complete the projects in Guangdong.

WESTERN CHINA

If you've noticed, while I've been preaching the values of first-tier cities, I'm also using examples of work that we've done in second-tier cities-because the price is typically much cheaper and quality levels can be comparable. So it can be more cost-effective. It just takes more work. In general, manufacturing in China takes more work and time than production in western Europe or the US; working in western China takes much more time and personal involvement to get things done right than working in first-tier cities in the East. So as we shift to looking directly at the second-tier cities the question really should be: What does it take to pull it off?

My favorite touting of a "successful example" of a company that moved to a second-tier city is that of Ford moving to Chongqing. Why is it my favorite? Because it has very little to do with the reality of either the advantages of Chongqing or how any other company on the planet would fare there. In theory Chongqing has some real benefits; It's on the Yangzi river, it's a traditional manufacturing center, it's got a huge population to draw labor from and the government spent a few billion dollars upgrading the infrastructure in the last decade. By all accounts it should be a great second-tier city. But, the fact remains that it's not even the first choice within Sichuan province for most companies moving inland. Chengdu with more universities and more commercial development-but fewer logistical services (no river access)-is a bigger draw. Ford was, no doubt, given huge tax breaks and other subsidies to move to Chongqing. When large companies move into town, they have the advantage of getting incentives as well as drawing many of the smaller support services to the new location with them. Most small- to medium-sized companies do not have either of those luxuries, obviously. In this case, very few other companies have followed Ford's lead in moving to Chongqing.

So as you question whether you can really pull it off, you'll need to understand and assess a few things. First, determine whether it is in your best interest financially and whether you are willing and able to make the extra effort to visit the factories. Second, understand what is happening in the second- (and even third-!) tier cities. And third, because each city is different, carefully examine which will offer you the features you find most important.

Frequent visits

I'm going to reiterate here a position that I strongly believe in: if you are not here (meaning in your factories) regularly, the quality of your product will suffer. There is a direct correlation between your number of factory visits and the quality you will eventually ship from China. The further inland you move, the great the number of logistics and quality-related issues you will have (not to mention the longer it will take to get to your suppliers). This does not mean that you shouldn't go west, but it does mean that you'd better be visiting more often if you want the quality to be the same. Unless quantities are massive, this extra QC alone can negate any cost savings you were expecting.

What's happening in the interior? Here's the cycle, in brief:

1. First mover factories are contributing to rising incomes across China and are spurring an increase in commercial development.
2. Big first movers are attracting other services.
3. More business & services means more disposable income and more people staying in their hometowns rather than going east to work.
4. Second-tier city markets are catching up to the East Coast.

There is much information on the current domestic markets and the development of the interior of China. If you're serious about moving into a second-tier city, there are a few other concrete steps that you need to take to prepare for setting up shop in the city that is right for you.

Things to consider when determining which city best meets your needs

First-Assuming you have found the primary factory you are going to be working with, you then need to scout the local support systems and secondary factories in the area. Just because big first-movers are into a city you like doesn't mean that all the resource you need are there yet. Personal example here: Making molded stamps in Shijiazhuang. We started working here in 2005 and found that we couldn't find a number of the secondary factories that we needed to support complete production. We couldn't get the mold work done satisfactorily, we couldn't find the quality PET packaging we needed, printing was purely domestic level quality and in the end we had to ship everything to another province for packaging. The city has a history of light manufacturing but that didn't mean that it was right for us; we were there because of a client's factory request. (We did discover that Shijiazhuang has a surprisingly good collection of foreign and domestic restaurants-certainly a plus when choosing a new location). Let it be a less-expensive lesson for you than it was for us by spending a little more time or money or whatever it requires to give you confidence that the support systems you need are in place.
Second-Ensure you'll have a good selection of educated employees. Smart people gravitate toward opportunities-and the majority of opportunities are sill on the East Coast. The standard of living is better, the facilities are better, most international companies have a presence there and so there are more job opportunities there. The educated in China are still mostly centered in the large cities of Beijing, Shanghai and Guangdong province. If you want a large pool of well-educated and experienced job applicants, you're going not going find as many in the second-tier cities. Do not read me saying that you can't find well-educated employees in the West, but don't assume that just because there is a new factory, a new freeway and a university that you're good to go in Guiyang just like you would be in Guangzhou. The good news is that more and more people are "staying home"-as evidenced by the fact that 2 million people didn't return to Guangdong province after this year's Chinese New Year celebrations. It's getting easier, but still plan on your search taking longer than it would in Shanghai. China Vortex, on March 30th, agrees with this lack of personnel. (http://www.chinavortex.com/2008/03/chinas-biggest-challenge-for-developing-the-west/)

Third-Resolve whether you're business can withstand the fact that a second-tier city's infrastructure, specifically internet access and other physical services, is not always up to speed-literally. One of the oddities that I've experienced as I work in different cities is the wide variance in internet speed and access. Most factories I've worked with, even those just outside of Shenzhen, have very slow internet access; international sites are much more difficult to access than what I'm used to from my Shenzhen home/office/Starbucks. If you are internet dependent for work-related information, this will be a major issue for you. Don't be deceived by the fact that the hotel you are staying in has relatively good access. Not all office buildings or industrial zones (or individual factories) have the same physical wiring. And international hotels are not held to the same standards as domestic providers. Further, just because the local office of China Telecom ADSL or cable is telling you how fast their services may be, if your building or area is not wired correctly it may be like drinking Red Bull though a baby bottle rather than the wide-mouth can they are advertising.

Fourth-Be aware of and comfortable with the available professional services. While you can access the lawyers at Harris and Moure from just about anywhere via the internet, the other physical services that you may need (notary public, copy centers, translators, IT, etc.) will be harder to find-not impossible, but again, harder than in the East. Brace for another personal story: As part of a larger project, we did some metal alloy work with a factory in that was recommended to us Jiangsu province. The factory was quite large, their supply chain quite good and their level of customer service very satisfactory. But their head engineer had just quit and his replacement was not yet up-to-speed (driving about 25mph in a 75mph zone, actually). We initially tried to outsource the engineering work we needed, but couldn't find the comparable level of professional service that we needed. We then worked with the factory to try to find someone to either supplement his skills or replace him and had little to no luck within Jiangsu. All the applicants we found were either not quite as impressive as their resume indicated or, if they were as good as advertised, didn't want to move to the city we were working in. We ended up "borrowing" an engineer from a Shanghai-area factory for the duration of the project.

Fifth-Become well-versed in the inter-province tariffs that might affect you. Inter-provincial tariffs are really an oft overlooked problem within China. China is much more like a group of loosely affiliated states than a unified USA. There is a great deal of regional and intra-provincial protectionism. This translates into fees and transportation limitations on many products moving between provinces. Some items-wood, some foodstuffs and even electronics, for instance-are more sensitive than others. I don't know all the laws or all the restrictions, but your factory should be able to tell you what they can or can't ship to where and at what cost. Make sure you know this before you ever place an order.

Enjoy your search!

A simple rule of thumb is this: If the city you are looking at has an "international" airport and a Starbucks you can be fairly confident that it has developed supply chain resources and a healthy middle class. I know, it sounds laughable, but there is value in simplicity (and the value of a good sense of humor cannot be overstated in some of the cities you may visit!) First, even if the "international" portion of the airport is only open a few times a week and only flies to the technically "domestic" airports of Taiwan, Hong Kong and Macao, you know that, in the very least, there are a few hundred regular business travelers coming into the city. You also know that you can get out if you need too. The airport also means that there is both passenger and freight services out of your potential city.

The Starbucks means that there is a decent middle class. Since coffee costs a hefty $2-$5 a cup, only people with money are going there; and to keep a restaurant in business you need a decent-sized pool of relatively rich people to draw from. Money typically means some degree of business development, which in turn means at least some educated employees and employees. The Starbucks also means that a relatively unique supply chain can be built in your city of choice. Remember, the resources that it takes to run a Starbucks are typically not found locally in second-tier Chinese cities. Finally, the Starbucks means that you'll have access to internet even if your home/hotel or office has issues-this happens more often than you'd expect. Even in Shenzhen.

As previously mentioned, each city is different and each will have its own strengths and weaknesses. Chendu is very strong in telecommunications, Tianjin in banking, Dalian in Japanese service industry, Nanjing in professional services, and Yiwu has a great regional market (like the Canton fair all year round). But beyond generalities, you'll have to do your own research.

Just about every week you can find someone writing about the opportunities in the second-tier Chinese cities. But not many of these authors have been there for more than a tradeshow or quick trip to write a story. Make sure that if you are banking your future on a second-tier Chinese city that you visit it first and talk extensively with foreign companies that are already established there.

Some simple starting points may be your own embassy, a local chamber of commerce, business and law blogs written by businesspeople in China, trade and manufacturing associations, sourcing websites and even travel agencies. Check out the series of articles on CNBC (http://www.cnbceb.com/Articles/2008/May/42/china-opener.aspx) for some general ideas.

Good luck!


David Dayton the owner of Silk Road International and currently lives full-time in Shenzhen China.He speaks English, Thai and Mandarin and has worked in Asia for more than 15 years.You can contact him at david@silkroadintl.net or at www.silkroadintl.net.

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