Made in China takes on whole new meaning

ANDY HOFFMAN - ASIA-PACIFIC REPORTER

SUZHOU, CHINA — The Globe and Mail

Published Saturday, Jul. 23, 2011

Work boots aren’t required at this factory. Shoe coverings are.

Before entering Celestica Inc.’s electronics manufacturing facility in Suzhou, about 110 kilometres west of Shanghai, visitors must step onto a machine that encases their feet in plastic.

The light blue booties keep street dirt and dust from contaminating the sophisticated telecommunications and medical equipment the Canadian company produces here.

Nearly all the electronics products that Toronto-headquartered Celestica manufactures in Suzhou are high-end. Workers here make things like X-ray printers and routers and switches, the critical hardware for telecommunications networks.

The plant shatters the stereotype that China is merely the sweatshop of the world, where cheap labour churns out inexpensive trinkets, toys and second-rate fare. What’s manufactured here must meet the standards of the world’s top medical facilities and the demands of the most heavily trafficked corporate communications systems.

One-third of the Chinese workers at Celestica’s Suzhou plant are engineers, and the Canadian company has a research and design facility in Shanghai.

“I don’t think there is anything we can’t build in China today,” says Brian Lau, vice-president and general manager of Celestica’s Asia sales group. “The products we are building here are all value-added products,” Mr. Lau says.

China’s manufacturing sector is quickly moving up the value chain. Where once it produced poorly made clothes and plastic playthings, Chinese factories are now capable of making sophisticated electronics or pieces of machinery each worth hundreds of thousands of dollars.

Despite the increasingly complicated production methods, China’s advantage over other manufacturers remains cost. In Suzhou, a 45-minute train ride from Shanghai, a typical assembly line worker in the city is paid between $400 and $600 a month, while an engineer can earn between $1,000 and $2,000 a month.

China’s move to producing higher-end products is driven by necessity. Labour costs, while far cheaper than in North America, are rising fast and value-added products are a key way to offset inflation and keep the country’s massive manufacturing sector competitive. Producing more sophisticated products is also boosting income for both workers and companies, helping China toward its long-term goal of shaping an economy driven primarily by domestic consumption rather than overseas export demand.

The Asian economic powerhouse’s ascent up the manufacturing value chain portends not only an evolutionary shift for the Chinese economy, but also serves as a massive threat to an already battered manufacturing sector in the West. High-end production remained the last bastion of manufacturing prowess for Europe and North America while Asia dominated as a low-cost producer. Now, factories in China like Celestica’s Suzhou facility are proving that China is ready to close the technology gap and produce sophisticated goods at a lower cost.

But China’s cost advantage is under threat. According to Asia-focused investment and advisory firm Intercedent, rising wages and an expected increase in the value of China’s currency means that mid-tier manufacturing wages in China will reach parity with minimum wage levels in the United States by 2017.

“If this occurs, then there will likely be acceleration in the repatriation of low-end manufacturing jobs from China to North America or they will move to lower-wage countries,” Intercedent said in a recent report.

With the knowledge that their advantage in producing low-end goods will soon be tapped out, Chinese manufacturers are moving to more-sophisticated products. Even with a shrinking wage gap with the West, China’s massive work force, production methods and well-established shipping infrastructure will help it maintain an advantage over rivals in Europe and North America.

Minimum wage costs have risen an average of 23 per cent in China over the past year. While surging wages are a relatively recent phenomenon for the world’s largest exporter, the shift toward higher-end, value-added production in China has been under way for some time.

The country has exported more capital goods than consumer goods since 2003, according to data compiled by the United Nations. While consumer electronics such as computers and mobile devices account comprise a large share of these capital goods, exports of capital equipment and machinery (like what is produced at the Celestica plant in Suzhou) are also on the rise, Will Freeman of GaveKal Research in Beijing, said in a recent report.

High-tech products accounted for just 19 per cent of China’s exports in 2000. In 2009, they accounted for 25 per cent, Mr. Freeman said. At the same time, the share of primary and basic manufactured goods has declined and the share of manufactured goods excluding electronics, transport equipment and machinery, declined even more rapidly.

The GaveKal report said that during past decade Chinese exports of capital equipment have risen from 2 per cent of the global total to 8 per cent, while the U.S. and Japanese shares of the market declined.

The manufacturing shift is being supported by both the central and local governments in China as the move complies with China’s 12th five-year plan – which sets out the central government’s key economic and social goals – and represents higher revenues and GDP for provinces and regions. That means that capital-equipment manufacturers are, in some cases, being given preferential placement near ports and better access to credit from state-controlled banks.

GaveKal believes Chinese production of more capital equipment and machinery is a positive for business and customers in the West because it will lower prices for higher-end goods and increase productivity.

“China does not just flood the world with cheap consumer goods. It also exports capital equipment that improves productivity abroad … The story of China’s export deflation is far from over,” Mr. Freeman said.

David Reid, a Canadian living in the interior mega-city of Chongqing, has seen China’s move up the manufacturing value chain firsthand.

He moved to Chongqing three years ago to work for The Silian Group, a massive Chinese state-owned enterprise that, among its many business units, produces LED lighting systems.

Silian had just purchased a company based in Victoria which was owned by U.S. giant Honeywell International. The B.C. firm had developed a technology to produce synthetic sapphire wafers in a laboratory. The sapphire wafers are then used in LED lighting systems.

Mr. Reid has helped transfer the Canadian-developed technology to a new Silian plant in Chongqing. The operation is now the only plant in China producing sapphire wafers. He says the quality of the Silian wafers from Chongqing is already equal to most overseas competitors in more-developed hi-tech manufacturing markets.

“If I didn’t put a Made in China label on it, they wouldn’t know where it came from,” Mr. Reid said in an interview. And because it is based in Chongqing, Silian’s production costs are far cheaper than competitors.

While overall manufacturing is slowing slightly, China’s production of higher-end products is surging.

In the first quarter of 2011, the machinery sector saw its output and sales increase by about 40 per cent from the previous year.

Jing Ulrich, chairman and managing director for JPMorgan in China, believes the production of higher-end goods will increase productivity, offset labour shortages and boost domestic consumption.

“The Chinese manufacturing sector’s labour productivity is still relatively low in global comparison, leaving much room for mechanization and more efficient processes that will allow for comparable levels of output with a thinner work force. Moreover, Chinese manufacturers face a booming domestic market, where demand for consumer goods is still in the process of being unleashed,” Ms. Ulrich said in a report.

The Celestica plant is another case in point. Ten years ago, the factory produced simple circuit boards and consumer-grade electronics. The Canadian company’s high-end products were still designed and built primarily in the West.

But the crash in technology stocks in 2001 forced Celestica and other electronics firms to find cheaper places to produce nearly all of their products, said John Peri, Celestica’s chief operating officer.

Like most of its competitors, Celestica looked to Asia – and specifically China – for cost relief.

In addition to Suzhou and Shanghai, it also has manufacturing facilities in Dongguan in southern China. Of the company’s 35,000 employees, 6,000 are in China. Celestica also has plants in other low-labour-cost Asian countries, including Malaysia and Thailand.

At the Suzhou plant, the major initial challenge was working with local component suppliers to be able to produce the correct parts for the next generation of products.

“The suppliers have kept pace with the requirements. Management has been key,” Mr. Peri said in an interview. Over 90 per cent of the components used in Suzhou are now produced in China.

As Celestica increased the complexity of the electronics products it manufactured in China, finding qualified workers was also an issue. But local universities now produce more than enough qualified engineers to staff the plant.

The Suzhou plant can now make the most sophisticated electronics the company produces for customers like Alcatel-Lucent, Hewlett-Packard, Cisco, IBM and Research In Motion.

The network routers the company builds in Suzhou, for example, have a possible 45,000 different configurations.

“I don’t think things get much more complicated than what we make there today,” Mr. Peri said.

The most striking thing about the Suzhou facility is how quiet it is. The hum of the factory’s bright fluorescent lights is the loudest sound as workers quietly assemble parts for ATM machines and other electronics.

Nearby, a worker meticulously checks the quality of an X-ray sheet from a recently built printer. The machines, which are shipped to hospitals all over the world, have more than 1,400 mechanical parts and are assembled in an air-sealed “clean room” where dust particles are almost non-existent.

While most of the products produced in Suzhou end up being shipped overseas at the nearby port of Shanghai, more and more are staying within China. A decade ago, Chinese customers accounted for just 10 per cent of sales; now they account for more than 20 per cent.

The Suzhou plant is expected to expand its production range to include electronics for the aerospace industry. As Celestica’s head of sales in Asia Mr. Lau points out, over the next 20 years, half of the world’s airplane production is expected to come from China.

“The vision is not just low labour costs. We are trying to target customers who have local sales here,” he explains.

“The local market is a very enticing factor.”