A comprehensive look at the pros and cons of doing business in China.

The Positives:

• Lower labor costs
According to a Boston Consulting Group (BCG) outsourcing report, the average hourly pay (including benefits) of production workers in China is $0.80 versus $21.86 in the United States; given the same equipment, American workers need to be 25 times more productive than their Chinese counterparts to remain competitive. Furthermore, if PRC government reforms on labor mobility succeed huge labor surpluses in the rural areas and underemployed workers at state-owned enterprises waiting in the wings may keep manufacturing wages competitive for some time.

• Long-term flexibility in production
Companies often overlook the fact that, once Chinese workers have been well trained, substituting human hands for expensive, specialized machines can actually improve the flexibility of production lines.

•Proximity to downstream manufacturers
For companies that churn out intermediate goods such as auto parts, refined chemicals, and machine tools, customers (other factories) are increasingly located in China. Paradoxically, moving operations to China nowadays can lower shipping costs in addition to lowering labor costs.

•Familiarity with the PRC operating environment
Companies with longer-term plans to supply the Chinese market can start with a sourcing operation, which enables them to explore their options and lay the groundwork for a move toward local production.

• Lower capital costs
For companies that plan to set up PRC manufacturing operations, land and setup costs can be a fraction of US costs, at least in the interior provinces and outside of major cities. Companies also find that using local components often minimizes input costs.

•Favorable tax structures
Foreign-invested manufacturers enjoy a tax rate of 15 percent, as opposed to 33 percent for domestic enterprises, and the government rebates up to 15 percent of value-added taxes (VAT) on exports. Though the government has plans to unify the business tax structure and phase out some of these incentives, localities are likely to continue to offer incentives to lure investors.

The Negatives:

As more foreign companies move to China, they are creating nuclei of high-quality production and are challenging local factories to compete not only on price but on quality and service.
China is equally well known as a tough environment for logistics and intellectual property rights (IPR) protection and as a lackluster enforcer of legal contracts. Specific difficulties in sourcing include:

• Initial start-up time
Getting a sourcing operation up and running may take longer than you anticipate, depending on the complexity of your product and your supplier's abilities. Finding a new supplier almost always requires new molds or new lines and plenty of quality control.

• A weak intellectual property regime
Foreign companies will find IPR protection a major concern for the foreseeable future, despite promising Chinese commitments on IPR made at April's Joint Commission on Commerce and Trade meeting between senior US and PRC trade officials.

• Increased management complexity
Adding an overseas branch or supply relationship requires stronger communication, stringent quality control monitoring, and a redesign of operations to adjust for different comparative advantages. The sheer geographical and cultural distance between the United States and China causes some small US companies to hesitate; even the 12-to 15-hour time difference can make teleconferencing a headache.

• Longer and more complex supply chains
Delayed delivery of consumer goods to US and European consumers is a risk unless companies manage their supply chains properly.

• Energy shortages and other operational setbacks
Last summer, factories across China were crippled by power shortages, which have persisted through 2005. PRC producers have borne the brunt of the power outages; some have been forced to operate only on the graveyard shift.

Source: This is an excerpt from an article originally published in the Sept-Oct, 2004 .issue of the China Business Review. Reprinted with the permission of The US-China Business Council, Washington D.C.

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