Preserving Profit Margins in China

Preserving, let alone expanding, profit margins in China are a constant challenge for manufacturers.

First of all, China is by far the most competitive market in the world. All of the companies from around the world that make any particular product are most likely already in China, and when they enter the China market, they are confronted with an army of local manufacturers of the same or similar products. While the products manufactured by many of the local companies may be low in quality and technology, they have the advantage of low price. Moreover, a growing number of the locals are improving their products to the point where they are approaching competitiveness with the international brands.

Secondly, China’s continued economic growth is pushing up prices. Higher per capita incomes are great for workers, but they also mean higher wages for manufacturers. Greater prosperity is creating tremendous wealth in the country, but that wealth also translates into higher rents as cash rich Chinese bid up property prices. Whether it’s wages, rents or raw material prices, China’s increasing level of economic activity is impacting costs across the board.

Finally, the integration of China, India and other emerging markets into the global economy is leading to a higher level of raw material prices. While higher input prices affects all manufacturers, wherever they are located, they are no less of a problem in China.

As I described the highly competitive nature of the China market several weeks ago to a group of INSEAD MBA students who were visiting China, one particularly astute student asked a question that I am often asked: “How does a company preserve its profit margins in China?”

Over the past several years, I have been a regular contributor to the “Opinion” section of BusinessForum China, a bi-monthly magazine published by the German Chamber of Commerce. In 2008, I wrote China’s Manufacturers Move Upstream which addresses the question posed by the student from INSEAD.

To summarize, I gave the readers of BusinessForum China, five ways to counter rising costs and intense competition to maintain profitability:

1. Constantly review your products and customers with an eye to eliminating those that are no longer profitable.
2. Accelerate and intensify lean manufacturing initiatives to reduce waste in your manufacturing processes and business systems.
3. Implement “value engineering” and product re-design to reduce the content of expensive raw materials.
4. Where possible, be aggressive about passing along higher costs to your customers.
5. Implement a comprehensive and continual product development program.

Of the five measures, the most important by far is the vitality of a company’s new product development activity. The reason is quite simple: profit margins are highest at the beginning of a product’s life cycle. As a product matures and more competitors enter the picture, prices and margins inevitably decline.

In a nutshell, stay close to your customers and help them improve their products or services. In doing so, you will stay one step ahead of the competition.

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