Having just returned to Qingdao after a fairly long absence, I met over the weekend with a group of expats engaged in various forms of manufacturing in China to get their take on current conditions and their feelings about the future. The participants in the discussion were from many regions: United States, Canada, England, Germany, Norway, Finland, India, Pakistan, Spain and Italy.

The discussion was interesting because the opinions expressed were very consistent. Every person said that they were having problems with their manufacturing in China and that they were interested in diversifying into other countries. They identified the following issues as causing them problems in China:

a. Rising wages. When productivity is factored into the analysis, China can no longer be considered a low wage country. Many participants stated that on a purely wage basis, Chinese manufacturing is not significantly cheaper than parts of the United States.

b. Rising costs. The main complaints were directed at soaring rental rates and rising utilities costs. Many of these costs were formerly subsidized. These subsidies are being removed and the cost is being reflected in the price of manufactured products.

c. Declining manufacturing quality. All of the participants in the discussion agreed that instead of improving, the rate of manufacturing defects has risen over the past five years. This rise in defects has been coupled with a general decline in service from Chinese manufacturers.

d. Increase in scams. In recent posts (see part 6 here and follow the links to the previous five posts in this “Scam Week” series) we have discussed the rising number of scams our China lawyers are seeing involving both foreign manufacturers and investors. The participants in this discussion have also seen a rise in irregular practices in the manufacturing sector. Swapping out product components for lower quality items was a major complaint and these swaps are happening more now than five years ago.

Given the above complaints, I asked the participants “To what country would you choose to move your manufacturing operations?” Their responses to this question was surprisingly consistent: they all agreed they would move to Malaysia or Indonesia.

Given the above, I assumed that a move for all the participants was imminent. So I asked the natural question: have any of you actually moved your operations out of China to the countries you have identified or to any other countries in the world? The response was surprising to me. In spite of the consistency of their complaints, NONE of the participants had moved their manufacturing operations out of China. Most had tried some other country, with Viet Nam, The Philippines, Malaysia, India and Bangladesh being the most common countries explored. But every person in the group had abandoned these plans and had either kept their operations in China or moved their operations back to China.

The reasons given for the returning to China or just staying here were as follows:

a. Inadequate supply chain. For larger, established companies the primary reason was the lack of a good supply chain. They found it impossible to obtain all of the components required to manufacture on a consistent and price competitive basis.

b. Low productivity. Though wages in the other countries were lower than China, the skill in manufacturing and the quality of factories is low. When calculated by productivity, none of the alternative countries showed any benefit when compared to Chinese manufacturers who have been in the business for 20 or more years.

c. Lack of engineering and design support. Foreign buyers of product from Chinese factories routinely make use of the staff of the Chinese factory to deal with final design and commercialization of product. Molds and tooling are routinely designed and fabricated in China. Production prototypes are designed by the factory engineering staff. When factories in the other countries are approached about these services, the factory staff is eager to learn, but the expertise is simply not there.

d. Small scale production is not available. Many foreign buyers come to China to manufacture small runs of product. One participant said he had just worked with a local Qingdao manufacturer on a limited run of 100 items for a new product produced to test the market. When I asked him if he could have a short run like that done in any country other than China, his immediate answer was: “Of course not. I can get these items made in Viet Nam, but I have to order at least 10,000 items. I also have to provide my own engineers and design staff and it just does not pencil.”

Every participant in our meeting was extremely critical of current manufacturing conditions in Chine. Every participant expressed an almost ardent desire to move out of China. Every participant stated they had made at least one effort to move production to some other country in Asia. But in the end every participant also stated they are currently not able to leave China because no other country offers the conditions required for small and medium sized companies to produce their product.

The general conclusion from the discussion was that it may be possible for large multinationals to move their manufacturing operations out of China to other countries in Asia. But for the “near future,” for start ups and for small and medium businesses, China remains the only practical place to do outsource manufacturing. What does “the near future” mean? The general impression was that this current situation will last for at least five years. Of course, “five years” really means “we just don’t know.” Or to sort of quote Winston Churchill, China is the worst place to manufacture your product except for all the others.