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2014 Media Kit

China costs start to worry US. multinationals

By: | at 08:00 PM | International Trade  

For years, low prices on China-sourced goods helped dampen inflation in the United States. Now China’s efforts to boost domestic consumer spending, reducing reliance on exports, are leading to higher costs for multinationals that manufacture goods there.

Eventually, China could export its inflation.

Conglomerates ranging from Emerson Electric to Honeywell International feel pressure on margins from double-digit wage increases in China. So have toymaker Mattel , fast-food chain Yum! Brands and computer maker Dell , analysts and investors say.

They have plenty of options besides raising prices, such as embracing automation or moving to China’s less-developed interior. Some companies relegate China costs to the category of minor headache; others point to long-term benefits from richer Chinese consumers. But the topic has became a talking point during the earnings season now winding down.

“Input cost increases have been a steady headwind to margins for some time now,” Fairchild Semiconductor International Chief Financial Officer Mark Frey said last month. “Metals and energy pricing, forex and China wage inflation are more difficult to forecast.”

Yum, the No. 1 Western restaurant brand in the world’s fastest-growing major economy, generates a third of its profit from China. It said its full-year margins will dip this year, citing labor inflation in the mid-to-high teens.

“I do believe that labor inflation will continue high for quite a while,” Yum CFO Rick Carucci said on the company’s earnings conference call. He called commodity prices another “wild card” for the company.

Go West, Young Man
Nearly a third of Emerson Electric’s total workforce is in China, where it employs more than 40,000 people. Amid 20 percent wage increases, the company has said it could move some production to China’s interior, and it might move 20 percent of its capacity to other Asian countries.

“The economy is going into a more costly mode,” CEO David Farr said on Emerson’s second-quarter conference call. “We are going to have to refix where we’re manufacturing.”

Emerson’s network power business was the only of its five units to show lower operating profits in the latest quarter. The company cited labor inflation among the causes.

“A lot of the wage increase is to keep civil unrest at a minimum,” said William Blair analyst Nick Heymann, who said suicides at an Apple supplier and the “Arab Spring” protests have alarmed Beijing. “These guys have watched North Africa and the Middle East with a lot of trepidation.”

A related, complicating factor is that local competitors, many state-owned and not too worried about margins, are challenging companies like Emerson on price, Heymann said.

Multinationals have figured out they cannot compete on cost: they must differentiate their products, making them smaller, faster or more energy-efficient. Then, depending on the product, they might be able to ask for higher prices.

Others, such as makers of labor-intensive shoes and toys, have to take into account a cost-conscious consumer now potentially facing a new recession. Still, Hasbro and Mattel have pushed through price increases this year, and Hasbro’s CEO has said China remains its preferred manufacturing hub.

Manufacturing a Consumer Culture
China this year adopted a five-year plan that calls for 7 percent growth in per-capita income, ahead of earlier targets, and fresh investment in research and development, to boost domestic consumption and modernize its economy.

Manufacturing wages are a fraction of those in the United States but are narrowing the gap, both fueling and responding to China’s inflation, now at three-year highs. Between 1978 and 2009, wages jumped almost 13 percent a year, six times the pace of U.S. wage rises, according to BernsteinResearch.

Since 2006, that growth has accelerated.
By 2015, wages around Shanghai, adjusted for productivity, will be 61 percent of those in low-cost U.S. states like Alabama, according to the Boston Consulting