Surviving China’s Rapidly Changing Sourcing Tides: Part I

About an hour ago, the webinar by the same name, hosted by and Aptium Global, and moderated by none other than Spend Matters own Jason Busch, wrapped up. This webinar had some fascinating insights into the current state of China sourcing, which has many people in a frenzy due to the massive VAT rebate changes that went into affect on July 1.

The current hullabaloo is due to the fact that on July 1, China cancelled VAT rebates on approximately 553 products, reduce the VAT rebates on approximately 2,268 products, and only exempted VAT charges on about 10 products. In other words, about 37% of the total classifications have had the VAT rebates slashed or eliminated. The VAT rebates were created in the 90’s at a time when exports were low to support growth in the export economy. However, now that there is a huge trade surplus with many trading nations, especially with the US ( to the order of 14 B ) China apparently wants to rectify the situation. Typically, Chinese companies are supposed to pay 17% VAT when they sell a product. Until recently, the VAT rebates drastically reduced (or eliminated) this tax on exports – but now that they are being eliminated, some products could end up costing you 17% more.

According to James Jin, the head of the Shanghai office, the purpose of the VAT Refund Change is to reduce the trade surplus, eliminate high energy consuming & resource intensive exports, avoid products triggering trade functions, and give China more spending power. As a result, there are will be increased export prices on lower value add products such as fasteners, extrusions, etc; serious financial pressures on Small and Medium enterprises in China with low margins, especially going through trading agents, and some of them will likely go out of business; and increased opportunities for imports into a growing, and opening, Chinese markets. In the short term, the rebates cause quite a panic among those suppliers being negatively impacted who caused major traffic jams during the last through days of June trying to get their products out of the country before the VAT changes came into affect.

However, according to a recent survey conducted by the China team, it looks like things aren’t all that bad. The Shanghai office conducted a poll of IPO (International Purchasing Organization) buyers on July 6 and received the following answers to the six questions presented:

  • What is the impact of the VAT reduction on your purchasing?
    Significant: 16%; Some 37%; Insignificant: 21%;
  • How much is the overall estimated purchase price increase?
    >5%: 26%; 3-5%: 11%; 0-3%: 21%;
  • How does material cost increase impact your China sourcing?
    Significant: 26%; Some: 26%; Insignificant: 32%;
  • What is the estimated price increase due to China material cost increases?
    > 5%: 22%; 2-5%: 33%; 0-2%: 17%;
  • What is your solution to the risk of increasing cost?
    Share Risks with Suppliers: 33%; Re-source in China: 22%;
    Switch to other Low Cost Countries: 19%; Maintain Pricing: 15%;
    Other: 11%;
  • What is your predicted sourcing trend for China in the long run?
    Increase: 79%; Decrease 11%; Unchanged: 5%;

In other-words, despite the fact that 53% of IPO respondents expect the VAT reductions to have some (negative) pricing impacts, with 37% expecting those price increases to be at least 3%, and despite the fact that 52% of IPO respondents expect material cost increases to also have (negative) pricing impacts, with 55% expecting those pricing increases to be at least 3%, 79% of respondents still expect to increase their China sourcing, with 55% planning to do so either by sharing risks with suppliers or re-sourcing to other in-country supply sources.

The Shanghai office also polled the Chinese suppliers and found the following:

  • How does the VAT refund reduction impact your exports?
    Significant: 6%; Some: 29%; Insignificant: 29%; Not at all: 36%
  • How much of a price increase is likely to result from the VAT refund reductions?
    >5%: 18%; 2-5%: 12%; 0-2%: 0%; Not Sure: 18%; 0% – 52%
  • How are China material costs impacting exports?
    Significant: 32%; Some: 18%; Insignificant: 28%; Not at all: 18%; Unsure: 4%
  • What price increases could result from material costs??
    >5%: 14%; 2-5%: 30%; 0-2%: 5% 0%: 41%; Not Sure: 10%
  • How do the export cost increases impact competitiveness for the North American / European markets?
    Significant: 26%; Some: 11%; Insignificant: 32%; Not at all: 26%; Unsure: 5%;
  • If impacted, what is the solution? ?
    Increase Price: 43%; New Customers: 19%; Reduce Costs: 15%;
    Change Products: 4%; Other: 19%

In summary, 35% of responding suppliers believe that the VAT will impact their exports, with 30% expecting at least a 2% increase, but I’d suspect they are still more worried about material costs with 50% expecting material costs to have a (negative) impact on exports and 44% expecting the associated price increase to be at least 2%. Fortunately, only 37% believe their competitiveness will be affected and 57% are going to look for solutions that do not involve increasing price.

But, as pointed out by James, what is really important to note is that, despite the recent smear campaign (and despite the fact that since 2005, 431 Chinese-made goods have been recalled in Canada alone), many China suppliers consistently perform well and to high quality standards. For instance, tracks ratings of all its suppliers, and 92% of China suppliers receive high or perfect ratings on quality, 96% of China suppliers receive good or excellent ratings on responsiveness, and 90% consistently deliver early or on time, giving them a rating of very good or excellent 72% of the time, and good or better 92% of the time. In other words, the vast majority care about the products they make and will work with you to correct any issues – but you have to manage them as you would your own plant and make sure quality materials, processes, and systems are being used.

Furthermore, as Mitch Free, founder of, pointed out, the recent changes, despite the fact that they are a big deal and will continue to be a big deal, are not all bad news. First of all, they present an interesting opportunity for American Suppliers to bet aggressive and start to bring business back home. They will need to employ advanced technologies and a great strategy to do this, but that’s not a bad thing. Furthermore, he also points out that this will force Chinese suppliers to elevate to a higher level of technology to compete, especially on lower value-add products, and this is good for everyone! Mitch, in responding to a listener question, also pointed out that a higher-value finished goods economy, like the one that matured in Japan and Korea is undeniably coming, but that the question is, as always, when. Due to China’s sheer size, it’s likely to take a long time. It’s also up to the government, who appears to be in total control of their market with their power to control exports, give and take VAT rebates, alter the value of their currency, etc.

This was a great webinar, and Lisa Reisman also had some great insights on how to properly assess and manage your China sourcing and low-cost country sourcing in general, but that’s the subject of my next post.

In the mean time, I’d like to point out, as re-iterated many times by moderator Jason Busch, that is launching a learning center next week to address all of the issues with China sourcing at and that this will include an archived version of the webinar, additional information on the recent poll, questions and answers to all webinar questions (including the many that they didn’t get to), and a slew of executive briefs on the relative issues with more to come as time goes on.

Until the learning center goes on-line, you can read and re-read the Spend Matter’s series on the subject in these posts: