Big Supply Chain Troubles in China

The 21st century has been, so far, a prosperous one for China. The country has become enriched by its powerful manufacturing industry, which offers low operational costs and a seemingly unending supply of cheap labor to companies across the US and Europe.

China's industrial complex has made the country the world's second largest exporter, behind Germany, according to China's National Statistics Bureau, and more and more products sold by US retailers are made by Chinese manufacturers. At Wal-Mart, for instance, 70 percent of the commodity goods on its shelves are made in China.

But China's rise to power on the world's trading stage has been dogged by controversy. There are the allegations of unfair labor practices, concerns about piracy, and of course, the product safety recalls. In fact, Chinese suppliers have become infamous in the US for product safety transgressions-from lead-paint Thomas the Tank Engine toys to toxic toothpaste and baby formula.

Such scares have further tarnished China's already dubious reputation in the world and have caused US-based companies, including Wal-Mart and Mattel, to lose confidence in their Chinese suppliers and to hold them to stricter safety and manufacturing standards.

"China has been damned up and down as the main source of risk when it comes to product quality, to IP infringement, to supplier failure when it comes to product defects," says Noha Tohamy, vice president of research at AMR Research.

As 2008 comes to a close, China's dominance as the world's leading supplier is in question. The factors threatening China's supply chain dynasty, including a worldwide economic recession, volatile energy prices that make shipping products from China expensive, and mistrust of Chinese products, are quickly stacking up like runaway train cars, each pushing the other down a dangerous track.

"It's clear that the Chinese do not have control of their supply chain and neither do we," said Michael D. Watkins, a professor at the IMD Business School in Lausanne and co-founder of Genesis Advisors, in a 2007 Businessweek article. "What we're seeing is the logical conclusion of an effort to drive prices down further. The tainted toothpaste was all about suppliers using cheaper ingredients. Everything in China is about driving down price. And now people have evidence that there's reason to worry."

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China Has Caught the US's Cold

The first and most important factor in China's decline is that the global economy is in full meltdown. In the United States and elsewhere, the consumer spending that drives demand for Chinese products has ground to a halt. As a result, China's once vast network of suppliers has been decimated. A recent article in the Financial Times reports that in China's largest export center, Shenzhen, 682 factories had stopped production or closed this year. Shenzhen has been China's leading export area since 1992.

Chinese consumer electronics manufacturers, which supply the guts of PCs, MP3 players, videogames and smartphones, are also struggling to remain profitable, according to market researcher iSuppli.

The apparel industry is suffering as well. The number of Chinese suppliers actively serving the US market dropped more than 70 percent in just three months-from 22,099 suppliers in July to 6,262 suppliers in October, according to the most recent supply chain data from Panjiva, which tracks the relative health of 400,000 suppliers in 140 countries.

"Those [Chinese manufacturers] that have a diversified customer base-including domestic Chinese customers and European customers-may be holding on by a thread," says Panjiva CEO Josh Green. "Those that are primarily dependent on business from U.S. importers are going under."

A China Backlash?

If there ever was a time to reevaluate a company's roster of suppliers, now is that time, say supply chain analysts, due to the economic uncertainty. Many companies are taking that advice, especially with their Chinese sourcing partners. The results of an AMR survey of 130 global companies, released in December, showed that those companies planned to move more of their manufacturing and sourcing activities closer to home, which is called nearshoring.

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Though respondents also planned to increase sourcing from China, the increase was less than half of what they had planned to bring closer to home. In addition, the small increase for sourcing options from China was half of what respondents had said the increase would be in a similar survey AMR conducted in May 2008. AMR's Tohamy writes in the report that the once huge cost advantage that China has held over other sourcing countries is narrowing. "More and more global companies are realizing that they can no longer put all their eggs in one basket: China," she says, in an interview.

China's reputation for low cost has always come with high risk. When asked what country or region contributes the most risk to their supply chains, survey respondents overwhelmingly chose China for nine of the 15 risks, including IP infringement (57 percent), internal product quality failure (52 percent) and security breaches (41 percent).

"This creates a dilemma for many global companies," writes Tohamy. "On one hand, they continue to enjoy the advantages of cheaper material costs and labor wages in China as well as the potential to reach vast consumer markets. On the other, however, they must continually reassess the pros and cons of operating in China."

And it seems for more companies, the risks of doing business with China are beginning to outweigh the rewards.

Tohamy notes that change is the one thing that supply chain planners and their companies can count on in 2009 and beyond. With China, she says, companies must continue to assess their global sourcing options and rebalance their sourcing partner portfolio to better manage their overall supplier risk-which will, in effect, reduce their reliance on China. "It's not going to be mass exodus [from China], and it's not going to be an immediate exodus," Tohamy says, "just an incremental change."