This spring, Grant Thornton LLP released a study entitled “Is China in Your Future?” which analyzed the current manufacturing conditions in China. The study is especially timely considering that U.S. companies who initially jumped on the China bandwagon have been hit with a one-two punch over the past 18 months: a spike in transportation costs and a bottoming out of the global economy.

Following are a few highlights from the study along with comments from Wally Gruenes, Grant Thornton’s National Managing Partner, Consumer and Industrial Products, serving Manufacturers, Retailers and Distributors. Along with Gruenes, the study was co-authored by Stephen Chipman, CEO, Grant Thornton, China Management Corporation. The entire study is available on WT100’s web site, www.worldtradewt100.com.

-Lara L. Sowinski, Editor





Each manufacturer must approach its China decisions on a company-by-company, supply-chain-by-supply-chain basis. At the same time, because manufacturing costs in China have risen in recent years (considering such factors as increased salaries, internal transportation costs, corporate tax rates, lease rates and environmental compliance costs), many manufacturers may prefer to look elsewhere in Asia or to keep production in their home countries. Other low-cost developing countries that may merit consideration include Vietnam and Bangladesh.

Even with the recent declines in industrial profits, there still are opportunities in China for certain companies. Many forward-looking organizations continue to ask: Is China in my future?

•    Should my company take advantage of China’s production capabilities? Can we build high-quality products while avoiding delays in an extended supply chain? Is the cost advantage between China and other options (including keeping work in the U.S.) still sizeable?

•    Does my long-term business strategy include selling to Western and locally owned domestic companies in the Asia-Pacific region? If so, what are our manufacturing and operational strengths, and how can we differentiate ourselves from China manufacturers? What are the first steps in developing these relationships in China?

•     Can we build facilities and produce in China? Can we capitalize on local pricing? Can we apply our cultural and organizational principles in a Chinese work environment?



Initially, manufacturers flocked to China because of the money. Most were compelled by the relative cost advantages and performance of factories in China, which earned an impressive 50 percent median return on invested capital (ROIC) in 2007. That is nearly three times higher than the median ROIC in U.S. plants (18 percent). Put simply, most China plants post excellent returns relative to U.S. plants.

Furthermore, the financial performance on plant floors in Guangzhou, Shanghai, Shenzhen and elsewhere in mainland China represents substantial cost savings for many North American manufacturers. The gross margin advantages may be impressive, but companies need to keep in mind that much of that margin is labor arbitrage. In fact, when comparing 2007 sales-per-employee productivity, the median in China is $205,200, nearly identical to that of U.S. manufacturers.

Given today’s economic environment, it’s particularly important that any decision to manufacture in China must be made with one’s eyes wide open to the practices common in the China manufacturing sector. Our research and the experience of Grant Thornton professionals “on the ground” in China note differences from U.S. practices in a number of areas, such as:

•     Customer reject rates

•     On-time delivery/overall equipment effectiveness

•     Labor and personnel-development practices

•     Quality improvement practices

•     Strategic initiatives and inventory management techniques, and

•     Marketing strategies



Although for the most part, the plant-floor metrics of facilities in the “2007 China Manufacturing Study” (conducted by the Manufacturing Performance Institute (MPI)) resemble those of Western firms. One notable exception: China represents a disadvantage in customer reject rates. China has a median 50,000 parts per million (ppm), compared to 100 ppm in the U.S.

In addition to labor and customer reject rates, China also differs when it comes to quality improvement practices. As one might expect, a well trained, empowered workforce is necessary to undertake improvement initiatives, particularly lean manufacturing and its culture of problem solving and use of the scientific method. So it’s not surprising that lean manufacturing hasn’t taken root in China. Just 25.1 percent of China plants report using lean manufacturing (vs. 69.6 percent in the United States). This could represent either a great opportunity for plants to improve performance or, conversely, the inability of China’s management culture to support lean manufacturing. Even among joint ventures and foreign enterprise plants, only 34 percent and 35 percent, respectively, report deploying lean and/or the Toyota Production System (TPS).

Finally, a high percentage of China plants (81.7 percent) report using Total Quality Management as an improvement approach, compared with only 34.2 percent that employ this approach in the U.S. This high percentage is understandable given the China Manufacturing Study’s population of ISO-certified plants. As in any market, however, one should be cautious when evaluating the ISO certification of plants. It is important to ensure that the procedures established to achieve ISO certification are consistently followed and actually producing tangible benefits.

If you are thinking about moving operations to China, you should consider the following critical issues:

•     Total costs: Do you really understand the total cost of doing business in China, and how that will change based on different scenarios (e.g., outsourcing vs. joint venturing or wholly owned manufacturing)? Have you done the math on freight costs, duties, inventory carrying costs, travel costs, etc.? And how will these costs change as China’s industry matures? How will your company take advantage of manufacturing capabilities in Asia and incorporate these benefits into a global strategy?

•     Impact on your customers: How does a global manufacturing and supply chain strategy affect your customers in the Asia Pacific region and the U.S? Should your company develop separate manufacturing and supply chain strategies for the Asian market and North American markets? For North American clients, what manufacturing and supply chain strategy will assure high quality, timely and right-sized deliveries, and order flexibility?

•     Risks and intangibles: What are you risking by going to China with sourcing and/or selling goods? Intellectual property? Proprietary processes? If it can be lost, assume it will be. Will your China partners be able to grow (managerial talent, skilled labor, etc.) as your firm needs? Can you ensure and document for your customers that the China goods incorporated into your products meet standards (e.g., green manufacturing and quality)?

•     Business environment: Do you fully understand the China legal, regulatory and reporting environment? Do you have the skills or resources to navigate the country’s famously complex bureaucracy? Are you prepared to grapple with the challenges of transfer pricing and tax-efficient structuring to maximize the value of your company’s investment?

Despite the economic slowdown, many U.S. companies continue to leverage the low-cost capabilities of China manufacturers and other benefits of doing business there. China still may be in your future. Take the time now to make sure your company is there for the right reasons.

Sidebar: Considering China: 10 Things to Think About

Grant Thornton LLP routinely advises clients with established operations in China, as well as those that are considering taking the China plunge. We work hand-in-hand with Grant Thornton International Ltd member firms in mainland China and Hong Kong, to provide seamless and comprehensive advice and service to our U.S.-based clients.

Based on our collective experience, here are 10 issues we urge you to factor into your decisions involving China expansion:

1. Transfer pricing documentation – Both Chinese and U.S. tax laws require intercompany transaction documentation. New Chinese rules require specific annual reporting forms to be filed with Chinese tax authorities, and contemporaneous documentation is a mandatory obligation for taxpayers if they meet China’s documentation threshold. The overall transfer pricing audit environment has become more stringent in China, and companies should ensure compliance to avoid transfer pricing audits and subsequent adjustments/penalties.

2. Tax-efficient structuring – Investments in China may be structured in a way that aligns a company’s global tax strategy with its operational plan. Tax-efficient structuring addresses the complexities of international tax laws and may provide a reduction in total taxes paid.

3. Tax compliance – One of the major issues faced by many enterprises in China is the emphasis placed on negotiation with authorities on the tax compliance process. Successful negotiation requires a comprehensive understanding of the tax system and the ability to reach a mutual understanding with tax authorities. It also is critical to develop sound relationships with knowledgeable tax authorities.

4. Accounting requirements – In recognition of the changing environment (due to economic reform and the open policy), accounting laws and regulations have been formulated for enterprises with foreign investment. These accounting laws and regulations are generally close to internationally recognized accounting standards, although differences exist. Statutory audits are required for enterprises with foreign investments.

5. Incentives for business activities – Incentives are available for various business activities. Under the new tax rules, most incentives are provided to enterprises that fall within “encouraged industries,” regardless of their location or ownership by foreign enterprises. These include customs and tax incentives and other preferential treatment.

6. Due diligence – Performing due diligence in China is very different from performing due diligence in the United States. While deal-makers understand that execution takes longer in China, many still underestimate the time it takes to close a transaction. Access to information in China may be restricted or difficult to obtain, and financial and tax records may lack transparency. There may be a need to focus more on operational due diligence as opposed to traditional financial due diligence.

7. Control of foreign investments – Exchange controls are monitored by the State Administration of Foreign Exchange and the People’s Bank of China. For foreign investment enterprises and individuals, revenue and expenses in foreign currencies have to be deposited with or withdrawn from accounts with the Bank of China or another authorized bank. After-tax profits or income on foreign investment enterprises or individuals can be remitted outside mainland China, provided tax liabilities due for covered transactions are appropriately cleared.

8. Corporate governance – The Sarbanes-Oxley Act of 2002 requires U.S.-listed companies, as well as their China operations, to document and evaluate corporate governance and internal controls over financial reporting. The newly enacted Basic Standard for Enterprise Internal Control, effective July 1, 2009, will require all listed companies in China (including domestic-listed entities of foreign enterprises) to assess and report on the enterprise’s internal control system.

9. Labor Contract Law – The Labor Contract Law, effective on Jan. 1, 2008, applies to all enterprises, individually owned economic organizations and private nonenterprise work units in China. Under the Labor Contract Law, there are four types of contracts, and the contracts must be written to establish labor relationships.

10. Enterprise Bankruptcy Law – The Enterprise Bankruptcy Law, effective June 1, 2007, provides for structured regimens of bankruptcy, restructuring and conciliation applicable to any People’s Republic of China-incorporated enterprises including state-owned enterprises and foreign investment vehicles. There are specific provisions dealing with cross-border insolvency issues.

Sidebar: Some Observations on the Study, by Lara L. Sowinski

Recently, WT100 talked with Grant Thornton’s Wally Gruenes, co-author of the study “Is China in Your Future?”, to get his thoughts about the findings. Overall, Gruenes believes that China continues to be a viable alternative for manufacturers whether they are actually manufacturing in China or just sourcing some of their product from China for use in their manufacturing process.

“In particular, China’s advantage is a labor advantage,” he says. “The cost of labor in China is dramatically lower than in the U.S.”

However, Gruenes is equally adamant about analyzing costs other than labor when considering China. “You have to think about the transportation costs, which really spiked last summer and fall. In addition, there are often times costs for re-works and other delays. Not to mention, there’s what I like to refer to as the ‘graveyard shift,’ or the time difference, which means a company must retain some of their executives at unusual hours in order to effectively coordinate with the other side of the world.”

Another point that Gruenes stresses is that companies need to sell into China. “You have to do it,” he says matter-of-factly. “If you are sourcing from China, that’s one thing. But, if you have a facility that’s actually manufacturing in China, or if you’re incurring the costs to manufacture in China, you must consider that a significant portion of production needs to be targeted at the Asian market. There are exceptions, of course, and depending on the product too. But, you really need to think strategically when you’re manufacturing in China. I would advise most companies to make sure that they can sell a large portion of their product in the local market.”

Most companies are aware of the need to sell into China, in large part because the sheer numbers of potential consumers in that country cannot be ignored, he says. Moreover, with weakened demand in the U.S. and Europe, China’s consumers are even more important.

A number of key improvements are helping bolster China’s consumer market. “One is that the wealth of the average Chinese consumer has increased over time due to factory-paying jobs as opposed to farm wages,” he explains. In addition, the transportation infrastructure is better today. “Clearly, it’s not at the level where it needs to be, but there has been improvement. Furthermore, it’s interesting that even though there’s been a dramatic decrease in foreign direct investment during the first half of this year, and even a decline in the consumer price index, on a nation-wide basis, equipment purchases and capital expenditures have actually increased by 25 to 35 percent. That’s largely been credited to the Chinese government’s stimulus plan, but I think it should be credited to Beijing’s recognition that there are major infrastructure needs that need to be addressed.” That’s welcomed news to the U.S.-based transportation and logistics companies who are operating in China, including Werner Enterprises and Schneider National. In 2007, Schneider launched Schneider Logistics (Tianjin) Co. Ltd. In Tianjin, a port city in the northeast, with services that included trucking, warehousing, freight management, and other transportation services. That same year, Werner Enterprises opened Werner Global Logistics (Shanghai) Co. Ltd. The office serves as the company’s Asian headquarters.

Meanwhile, U.S. companies have long complained about lack of IPR protections in China. Gruenes puts it bluntly: “When it comes to the proprietary processes, or the ‘secret sauce,’ you have to assume that if it can be lost it will be. Frankly, that’s why many companies avoid providing high-level information or technology to the local marketplace. You often times find that the very technical piece of manufacturing or design is done in the U.S. or Europe, and the less technical component of the process will be finished in China. A good example is the semiconductor industry, where the ‘front end’ design is done in North America or Western Europe, and the ‘back end’ like the cutting and componentizing and packaging takes place in China.”

Another consideration, according to Gruenes, is management. “Do your suppliers or joint venture partners have the management skills and talent that you need?” he asks. “While China certainly has many bright individuals from a business perspective and a manufacturing perspective, the concept of managerial talent and business management, at least in a Western sense, is still a relatively new concept.”

At the same time, several countries are emerging as viable alternatives to China, he says. “We see many companies moving towards Vietnam, Bangladesh, and India, although it really depends on what industry you’re referring to. The main attraction seems to be lower costs, but what we always advise our clients is that if you’re always chasing the lower costs then you’ll be moving somewhere else in five years. You need to think long and hard about moving between countries frequently, especially if you have a manufacturing presence in a particular country.”

When asked if there were any real surprises in the study, Gruenes says: “The high level of customer rejects surprised me a little-it was a high number of customer rejects relative to U.S. plants, especially when you consider the level of finished products that passed the quality inspection.” Another reason, says Gruenes, that companies must really “do the math” to determine if China’s in their future. wt