Why is everything made in Chiiiiiiinnnnnnaaaa???
His parents give him the standard, simple answer: “Cheap Labor. That means cheap prices.”
There is some truth here for sure, but it really over-simplifies the off-shoring dilemma.
The fact is, depending on the type of product your manufacturing, labor is certainly a cost to manufacture a product, but it’s not the ENTIRE cost of goods. If you’re dealing with a food product, labor may be less than 1/3 of the total cost. The balance?
Then the cost to the end consumer is made up of a couple of other major components:
Variable Selling Expenses:
Transportation – To get the product to the customer (distributor, retailer)
Sales Commisions – To third party selling agents
The last major variable, and the biggest variable
A manufacturer’s expected profit Margin
Yet another variable, the retailers profit margin….
The China “labor factor” is certainly relevant. But I would argue that the final consumer will see the end retail price move 5-15% (MAX) due to an off-shore model vs manufacturing in the good ‘ol USA. And 15% is pushing it….
So why do manufacturers make the decision to move production off-shore? Usually 2 reasons.
- Competitive pressure: Their competitors are already there, so if they DON’T go off-sure they are at a disadvantage
- Customer Pressure: They value “made in the USA” but not enough to pay a premium to make it in the states.
Those are 2 valid reasons. But at the underlying core is the following:
- The products are not differentiated enough, so cost comparisons become a driving force on decision making
- Since the products are not differentiated, the small %’s in cost difference are monumental to the business model. Margins are tight, can’t absorb increases. Margin is one of the critical metrics in business.
- The brands to not command an “emotional connection” with the end users.
In consumer products, Cost structures and Brand Value matter. The brands that have both, an emotional connection and a lean cost structure tend to write their own ticket. They have pricing power when costs move on them. Their margins tend to be substantially stronger than competition. As a result, they are not prisoners to the off-shoring pressure.
Lean cost structure + a Brand with an emotional connection to the consumer = a stable, sustainable margin.
It’s the holy grail of business.
An interesting read, geeky but data based study….