Why Chinese Manufacturing Wins

Dec 27, 2018 Michelle Clarke
At the end of the first millennium, around 1000 AD, China was definitively the most powerful country in the world. More than a third of the world lived within its borders, it's technology was the most advanced in existence, and its economy accounted for an astronomical 50% of the worlds GDP. The west paled in comparison to China, but eventually, Europe arose from its dark ages, the importance of China diminished, and the west came to rule the world.

Today that is still largely the case, but China is rising again. In 1978 China had a GDP of only $200 billion, only about 4% of the world's GDP, but nowadays that GDP has risen to $11 trillion and accounts for 15% of all economic activity in the world. This economic renaissance of the last 40 years is largely thanks to one industry—manufacturing. We've come to accept that China is the world's factory, but it wasn't always this way.

In the early 20th century goods were often just produced right near where they were sold. America made American goods, Europe made European goods. It wasn't until cheap, worldwide shipping became available that the production side of a company could be relocated to the other side of the world, but why did China win? How did this country become the manufacturing giant it is today?

 In 1978, Deng Xiaoping took power in the People's Republic of China. He quickly visited Bangkok, Singapore, and other flourishing Asian cities and was convinced that, in order to succeed, China needed to open itself up to the outside world, at least to an extent. He gave people control of their farms, privatized businesses, and, most importantly, allowed foreign investment in the country for the first time in decades. He opened up four special economic zones with tax incentives and exemption from the oversight that the rest of the country saw on its investments and trade activity. These four zones were essentially the free market portions of China, but none was more successful than Shenzhen in the Guangdong Province.

Before its designation as a special economic zone in 1980, Shenzhen was a tiny town with about 30,000 inhabitants but today that's grown to nearly 18 million people. That means its size rivals that of New York and London. It's believed that Shenzhen might have been the single fastest growing city in human history. Every other Special Economic Zone was an established area before its designation, but Shenzhen made sense as a spot where China could embrace the west as it lay just north of the border of Hong Kong—what was at the time a British territory.

Today Shenzhen is the electronics manufacturing capital of the world.  Shenzhen as a city is really known for two things. One is manufacturing capabilities especially for consumer electronics products and second, its gravitation for talents or human resources especially on the product development or research and development disciplines. Apple, Samsung, Microsoft, Sony, Canon—they all manufacture products here in Shenzhen. In fact, 90% of the world's electronics are made at least in part in this city. Everything just costs less in China so labor costs less too. Where a factory in the United States might pay upwards of $10-15 an hour, a Chinese laborer would happily accept $3 or $4 an hour in Shenzhen.

China has artificially depressed the value of their currency. Up until 2005, the Chinese government just said that the exchange rate was 8.27 yuan per dollar and that was that. They then went a few years allowing it to increase in value within a margin, but in 2008 they pegged its value again to make Chinese exports more attractive during the financial crisis. Nowadays, the government just picks a exchange rate daily and lets the currency fluctuate from it by up to 2%. This just makes it so western companies can buy more for less.

China also doesn't charge taxes on exports while the US doesn't charge taxes on imports. The US doesn't even charge customs fees for some products like tablet PC's so some products can make it all the way from their factory in China to stores in the US completely tax free.

In Shenzhen there are markets where you can buy every part imaginable, there are factories ready to build prototypes in a matter of days, there are engineers ready to work at the drop of a hat. Development just happens faster in Shenzhen. A US company might use the same factories as one based in Shenzhen but the geographical distance makes production slower. In addition, word travels fast in Shenzhen.

A few years ago Anker was first-to-market with a technology called PowerIQ that allows for faster device charging. The engineers from Anker told me that a big reason they were able to go to market before the western companies was because they heard about it first thanks to their proximity to other engineers and companies. Shenzhen just produces things better and faster, but a product isn't just a physical item.

What Shenzhen can't build as well is brands. Certain companies like Anker have been able to build a brand to an extent thanks to smart PR and marketing, but some other companies just don't bother. Lucrative western consumers want familiar and approachable feeling brands but cultural differences and geographic distance often make China based companies just seem different.

When the designers are thousands of miles away from the consumer they might not be as knowledgeable of their wants. Some companies have sprung up in Shenzhen whose whole business is to develop and produce products without a brand. They're called "white label companies". They might produce earphones, for example, then sell them to a western audio company who will attach their brand and sell the product at a mark-up.

Despite its enormous role in increasing the GDP of China 30-fold in the last 30 years, manufacturing is not an entirely sustainable industry for the country long-term. The problem is that, rather ironically, the economic growth that manufacturing spurred in China has increased labor prices to a point where their manufacturing is less competitive.

Before manufacturing came in China was a country of poor, rural farmers but today China has a real middle class and cities that are expensive to live in. It used to be that workers like the ones at Anker's factory moved to the city for a few years when they were young to make money for their family back home but nowadays people are moving to cities permanently and want to be able to set up solid, middle class, urban lives. The average cost for real-estate in central Shenzhen is almost $1,200 per square foot. That's even higher than San Francisco and New York. Even when workers live outside the city center, higher wages are necessary even just to pay for housing. At the same time manufacturing is becoming less labor intensive every day as robots and automation are becoming increasingly advanced and inexpensive.

In 2015 China launched a initiative spending hundreds of billions of dollars each year to upgrade and automate factories in order to keep prices low, but this will likely do little to keep companies from packing up shop and moving elsewhere. Manufacturing lines that can be automated are likely to move back to the United States and the rest of the western market. Robots cost the same whether they're in the United States or China so manufacturing products in the US helps save on shipping costs and certainly is good for PR.

At the same time, the labor intensive jobs that China prospered on in past decades are moving to less developed and less expensive countries like Vietnam, Bangladesh, and India. Chinese manufacturing firms are responding to this by opening up their own factories all across the world—everywhere from Africa to the United States itself. The model that might work for China in the future is that of Anker—Chinese based firms that can take advantage of their proximity to the production lines to cut down on development cost and time.

Shenzhen based start-ups like Anker, DJI, and OnePlus have already succeeded in taking advantages of this proximity, but more are being established each day. If you see a hardware-based Kickstarter campaign, there's a good chance it comes from Shenzhen. 10 years ago a company would be hard-pressed to succeed in Shenzhen as its own brand because historically the retailer has acted as a barrier in between the manufacturer and consumer, but with the rise of Amazon and other e-commerce sites its now possible for eastern companies to sell directly to the western consumer in a system that rewards for quality over price. The time really is ripe for Chinese entrepreneurship.

While Silicon Valley might be the dominant area for software start-ups, its hard to rival Shenzhen as an ecosystem for hardware development and manufacturing.

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