Something unusual happened this year in China following the Chinese New Year Spring Festival-many of the migrant workers who keep the assembly lines running in factories located along the country’s coast didn’t return to their jobs after the holiday. Rather, when they returned to their homes in the interior provinces during the break, they ended up staying there.

“For years, migrant workers from inland China would come to the coast in search of work,” explains Pilar Dieter, director for Alaris Consulting – China, based in Shanghai. Assembly-related jobs were plentiful due to the proliferation of manufacturing plants along the coast, and migrant workers were better able to support their families.

Workers usually returned home only once a year, during the Chinese New Year. But this year, and indeed in the past few years as a growing trend, was different-many migrant workers didn’t return and it’s doubtful they ever will.

Going West

The reason, explains Dieter, is that there’s been an ongoing shift in manufacturing in recent years from the coastal regions to the inland provinces, which means more jobs as well. “Workers are now able to find work in the places they were migrating from,” she says.

Auto parts manufacturers were among the first in the manufacturing sector to seek out inland locations, although other sectors soon followed. The resulting labor shortage along the coast is “very real, and very painful for some” notes Dieter, and “manufacturers are beginning to realize that their original business model may now need some adjusting.” Not only is labor an issue, but real estate costs are rising as well, as are construction costs for building warehouses, for example.

At the same time, competition among the interior provinces is heating up to attract foreign investment while the transportation and logistics network is steadily being improved to support the needs of global manufacturers.

“The emphasis is no longer just on moving products from factories around China to the ports for export,” affirms Mark Millar, managing director of M Power Associates. “Now, there is just as much emphasis on moving goods within the domestic China market to reach the increasingly prosperous consumers located all over this huge country.”

Millar adds that, “More than half the population now lives in cities, and the growth drivers of domestic consumption are the consumers living in second- and third-tier cities in central, western, and northeastern China, far away from the first-tier cities of Shenzhen, Guangzhou, Shanghai, and Beijing. These cities include provincial capitals such as Kunming, Hohhot, Xian, and Urumqi and hundreds of other municipalities whose names are rarely heard outside China, but have populations measured in millions. The goal of brands and manufacturers-both local and international-is to work out how best to capitalize on this expanding consumerism in the hinterlands.”

In fact, the westward movement is being led by some of the world’s most influential companies. Last October, China Applied Materials (as in Santa Clara, California-based Applied Materials, the largest supplier of semiconductor manufacturing equipment in the world) opened its Solar Technology Center in Xian, a city about 600 miles southwest of Beijing. It’s no secret that China is quickly developing into a more advanced economy. In the area of clean technology, the country is leading too. It’s estimated that by the end of this year alone China will be producing two-thirds of the world’s solar panels.

And, it’s not just the U.S. ‘company’ that’s moving to China, it’s the top executives as well. Mark R. Pinto, the chief technology officer for Applied Materials, moved his family to Beijing in January. He becomes the first CTO of a major American tech company to move to China.

Pinto told the New York Times last month that researchers from the U.S. and Europe need to be ready to follow if they want to do cutting-edge work on solar manufacturing because the new Applied Materials complex in Xian is the only research center that can fit an entire solar panel assembly line.

Xian boasts 47 universities and other higher-education schools, and the going rate for engineers with master’s degrees is about $730 a month. To attract Applied Materials, the Xian city government offered the company a 75-year land lease at a deep discount and is reimbursing the company for roughly a quarter of the lab complex’s operating costs for five years, stated the Times.

Competition among China's provinces

The incentives offered to Applied Materials to invest in China are becoming increasingly common as provinces compete against one another for foreign investment, says Alaris Consulting’s Dieter.

“More and more variables require attention as firms embark on their site selection activities-particularly manufacturing firms,” she explains. “Provinces are fiercely competing to entice foreign investment in their cities by offering attractive incentive programs to multinational and even some domestic firms.”

As multinational board rooms are becoming a revolving door of provincial leaders coming to meet heads of Fortune 500 firms in Beijing and Shanghai in an effort to entice them to establish their new factories in their province, steep benefits are being offered to lure the investment dollars their way.

“For instance, tax holidays are a frequently described perk,” says Dieter. “Some companies are being offered tax holidays for the first 3 or 5 years of operation. Other perks include offers by provinces to install subway lines so that a company can have better access to local labor. And, if there’s a university near a proposed site location, the province will sometimes offer to set up programs to provide interns or research facilities through the university to support the company. Pollution credits, housing allowances and interest-free business loans are also being offered. In an era where cash liquidity has been tough to come by, this can be seen as a most attractive incentive.”

The steady stream of foreign investment into China is helping the provinces afford these wide-ranging perks, although Beijing is doing its part at the national level, Dieter explains.

“The federal government is funding the build-out of the country’s infrastructure to help improve the production capacity of China. Furthermore, to the degree that foreign investment contributes to China’s GDP-a factor very closely monitored by Party officials in Beijing, the federal government recognizes these incentive programs being put in place by the provinces as a national initiative.”

In Shaanxi province (of which Xian is the capital), more than 4,000 foreign companies invested $1.5 billion there last year; Sichuan province raked in $3.2 billion in foreign investment from January to November 2009; and Chongqing attracted a whopping $4 billion in total foreign investment last year.

According to the Ministry of Commerce, the three provinces’ foreign investment accounted for 9 percent of the national total of $90 billion in 2009.

Action along the Yangtze

Dieter says the Yangtze River, which stretches 3,914 miles through seven provinces and handles 80 percent of inland water transport traffic in China, is responsible for much of the inland development and provides a further incentive to companies considering migrating west from coastal regions.

“Trucks are still the primary mode of logistics transportation in China,” she says, “but China has amazing resources when it comes to their waterways, and they’re starting to get leveraged more and more.” The caveat though, says Dieter, is that “if you’re moving cargo by barge, you’re obviously very reliant on water levels, yet those aren’t consistent throughout the river(s). Furthermore, transit times are also extended when transporting by barge, which can have a significant drag on a firm’s lead time and service levels in their supply chain.”

To get an idea of the transit times from key inland destinations, Dieter said moving cargo from Wuhan to Shanghai would take about 30 hours by truck or 4-5 days by barge. From Chongqing, the most significant port on the upper Yangtze, a truck trip to Shanghai would take about 3-4 days compared to about 10 days by barge.

Getting a handle on logistics costs

While manufacturers are certainly enticed by the attractive offers being put forth by the provinces, coupled with the access to cheap, university-trained talent, supply chain executives recognize the inevitable increase in their logistics costs, which are naturally going to be higher, she cautions. That’s spurred a jump in site selection services to help companies “run the entire cost arbitrage” to figure out where they should invest, Dieter says.

Of course, it’s very important for companies to consider the quality of logistics services available in inland provinces. And according to Dieter, the logistics market hasn’t quite developed with the same speed in the interior, and with good reason.

“For starters, the whole concept of ‘go west’ has been talked about for years in China, so the reaction has been ‘ho hum’ from the logistics providers. Truthfully, it’s more of a race to come in second place…no one wants to be first to make the investment in logistics facilities in an area where the infrastructure in merely ‘improving’ and provincial policies related to logistics and foreign trade are still being tested; they want to see how their clients’ logistics needs in these remote regions will be sustained and what level of logistics center investment by the 3PLs is truly warranted.” Logistics providers and industrial developers alike are certainly not adopting a ‘build it and they will come’ attitude, adds Dieter, if anything, they’re balancing their foray into the interior with their customers’ demands. 

Mark Millar acknowledges the tough decision that foreign companies historically had to make when it came to logistics providers. “For quite some time, one of the biggest questions to consider when outsourcing your logistics in China to a third-party logistics provider was whether to work with a local Chinese 3PL or an international 3PL, and the options were reasonably clear. The local Chinese 3PL companies had the on-the-ground knowledge, local connections, and operate on a lower cost basis. The drawbacks were that they didn’t have the depth of industry knowledge or sector-specific expertise, their staff was inadequately trained, and the IT systems were not at the standard needed by multinational corporations.”

That division has become “increasingly blurred,” however, says Millar. Furthermore, the 3PL industry remains “huge and unwieldy,” he remarks. “Almost three-quarters of a million companies are thought to be involved in the logistics industry, making it highly fragmented, with the top 20 companies having only a 7 percent share of the total domestic logistics industry.”

There is hope, however. Last year, China’s State Council unveiled the Logistics Industry Rejuvenation and Development Plan, which in addition to creating a network of logistics zones, corridors, and links between 38 key cities, will also emphasize “skills training and certification along with more cooperation with overseas research institutes and education providers that can bring international standard training courses in to the local market,” explains Millar.

“For the customer, this can only be good news. The service levels of the industry should come up, costs should come down, and therefore customers will get better value. These are encouraging developments, which we will watch with great anticipation.” wt