Is Low Cost Country Sourcing to China Really Innovative?

Since I haven’t been to China, and haven’t been involved in Chinese outsourcing (after all, software technology outsourcing was dominated by India firms during my software career), I’ve been hesitant to post on this topic. However, after reading Low Cost Country Sourcing in a Flattened World by Brad Blonkvist and John Kamauff in Chief Supply Chain Officer magazine, I just couldn’t hold back anymore. It finally pointed out the solid facts behind the anecdotal basis of my fears – China just does not have the physical infrastructure to maintain its current growth rate (despite the fact they are building 4.2B railways).

In order to scale up production, you need a certain amount of infrastructure. First of all, you need qualified engineers to staff your factories, plants, or service centers. On a per capita basis, China has only 8.6 students for every 1000 residents, as compared to 56.2 for the US. Furthermore, the studies that claim China graduates considerably more engineers and scientists each year are false. Consider the recent report Framing the Engineering Outsourcing Debate: Placing the United States on a Level Playing Field with China and India , by researchers Gary Gereffi, director of the Center on Globalization, Governance, and Competitiveness at Duke University, and Vivek Wadhwa, executive in residence at Duke’s Pratt School of Engineering, as summarized by the National Science Teachers Association (NSTA) on the NSTA WebNews Digest. Even though media reports in 2004 indicated that China produced 600,000 engineers compared to the 70,000 produced by the United States, the study found that more than 290,000 of the Chinese degrees were subbaccalaureate. After all, since the Chinese figures consist of data from different provinces that have no standard definition of engineering and include “the equivalent of motor mechanics and industrial technicians”, its clear that the actual numbers of graduates with US and EU equivalent degrees is much less then advertised. The Washington Post also ran a good article on this topic.

Furthermore, studies by organizations such as the McKinsey Global Institute have indicated that multinationals find that less then 25 percent of the graduates are employable. When you add the considerable language barrier into the picture, this indicates that the number of qualified engineers in China is considerably less then what many firms believe, and despite China’s large population, probably less then the number of qualified engineers in the US. Furthermore, it costs a lot of money to turn those who are qualified into productive workers. In Outsourcing to China, a special report from the Economist, the article points out that foreign companies in China are spending a small fortune “subsidizing China’s education system”. As an example, it points out that Fujitsu‘s Mr Noshiro has put some 40 Chinese workers through intensive training in Japan, at a cost of $30,000 a year each. “They need two years of full-time training just to become a middle-level engineer and four years to get to be a project manager.” Furthermore, even after three years of training “only 10-20% of programmers ever get to a really good level and can become an architect. China has so many colleges and so many graduates, but the degrees are not as good as they sound.”

Secondly, you need raw materials to build and run your plants. China is already importing more then its fair share of raw materials on a global basis. In addition to currently being the world’s largest importer of steel, it is importing 47% of cement, 21% of aluminum, 37% of cotton, and 30% of processed coal on a global basis. How much higher can these numbers go and be sustainable?

Thirdly, you need an infrastructure to get your raw materials in and your finished products out. Dozens of articles have been pointing out the infrastructure shortcomings in terms of paved roads and highways in India for a while now, but outside of a few big cities and central areas, China’s infrastructure is actually much worse. This shouldn’t be surprising as China only has 7 cars per capita compared to the 481 of the US. In addition, China has less then 150 airports compared to the 19,000 in the US.

Fourthly, you need energy to operate your plants – and this is where the numbers get really, really scary. Up to 30% of factories in China are periodically idle for weeks at a time due to power outages. According to the article, Northeast China is expected to exhaust power generation capacity by 2010! But if the rate of outsourcing to China continues to increase, I would predict that this could happen by 2008 – which is only 2 years away! After all, the actual increase in energy usage last year was 15%, not the 5% that was predicted. As it stands, China’s energy needs are expected to double by 2020 at the latest!

Fifthly, you have to protect yourself … but IP protection in China is almost nonexistent. I’ve read and heard too many stories of company X outsourcing product W to company Y who turns around and sells cheap knock-off Z in China which is undifferentiable from your product to the average buyer.

In other words, China, an emerging economy, is about to face a number of very significant problems simultaneously in a very short time frame – problems that the US, an established world superpower, has been battling for years with only limited success (think about the California or NorthEast energy grids, the fact that most major cities now have five and ten year plans just to alleviate current levels of traffic congestion, and the significant amounts of imports the US already requires). And I just can’t envision China coming up with a miracle to prevent the abrupt halt that is in its near future if outsourcing to China continues to increase at an exponential rate.

Now I know China is working on their infrastructure, but they are still concerned with connecting remote provinces by road and rail in efforts to integrate their people into one culture. Furthermore, as illuminated in Train to the Roof of the World, in their efforts to achieve these goals, they are taking considerable risks. For example, in their efforts to connect Tibet, and its capital Lhasa, to the rest of China, they are building a railroad over permafrost that could melt in the near future, especially considering global warming, which is not a myth and happening now. After all, concentrations of greenhouse gases such as methane and carbon dioxide today are the highest seen (40% higher than the highest concentrations measured) in the last 440,000 years, as determined by ice core research, which has removed cores 1.8 miles deep in the Antarctic.  

But then again, as I’ve stated above, I’m not an expert, nor have I been to China. So I’m going to invite thought leader Jason Busch of Spend Matters who has been there and is a strong believer that the best is yet to come in outsourcing to China to use his open mic as soon as he crawls back online and tell me why I’m wrong and how China is going to solve these problems that have plagued the US and its northern neighbor for years – and do so to a sufficient degree in the next three years before the impending energy crisis begins what could be a quick, and massive, collapse.  

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