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Manufacturing in China: The Key Decisions

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Manufacturing in China: The Key DecisionsAn Interview with Scott Ellyson, East West Manufacturing, Inc.

Ten years ago, Scott Ellyson and Jeff Sweeney co-founded East West Manufacturing (www.ewmfg.com) in Atlanta to bring U.S.-based companies both the cost-savings and speed-to-market offered by Asian manufacturing, along with the quality control Western companies demand. They began by forging partnerships with a number of manufacturing facilities in China, Thailand, Vietnam, Taiwan and India. Later they purchased factories for their team to operate in Changzhou, China and Ho Chi Minh City, Vietnam. Today, East West Manufacturing is a recognized, respected expert in the planning, design and implementation of offshore product manufacturing for original equipment manufacturers and distributors. The company’s transparent supply chain, on-site quality control and logistics systems reduce the risks and complexities of offshore manufacturing.

Scott Ellyson recently shared his experiences with Penelope Prime, the Director of the China Research Center. East-West Manufacturing, Inc. is a sponsor of the Center.

Prime: You have been working in China for well over a decade. Give us a sense of what has changed and what has stayed fairly consistent in terms of the environment for foreign businesses.

Ellyson: I made my first trip to China in 1993 and since then have returned more than 100 times. Back then, the sight of a foreigner was so unusual, children would come up to me and touch me. Now, Westerners doing business in China is commonplace. In terms of manufacturing, it’s amazing to see the country’s transformation in recent years. China has done in 15 years what it would take most countries 50-60 years to accomplish. Their rapid evolution from an agrarian society to an industrial one is remarkable, and makes me wonder what they will accomplish in the next 15 years.

When East West Manufacturing began working in China a decade ago, China’s laborers had a well-deserved reputation for their strong work ethic, and the costs of manufacturing were among the lowest in the world. However, the country’s poor infrastructure, low-tech suppliers and inexperience with quality control posed difficult challenges. Companies could manufacture products quickly and cheaply in China, but distribution was difficult and product quality was almost never up to U.S. standards.

Let’s compare the above scenario with today’s business climate. In a remarkably short time, China has built modern freeways, high-speed trains, subway systems and five-star hotels to host business travelers from around the globe. There are high-tech suppliers in place who actively promote their capabilities internationally. While the laborers still work extremely hard, there is a new emphasis on work/life balance. Although the cost-savings of manufacturing in China versus domestic manufacturing are not what they once were, the Chinese have become more adept at managing quality control and they have a greater understanding of the quality demanded by foreign-based companies.

One other striking change is the attitude of the customs agents and other government officials who work with foreign businesspeople. Years ago, they were suspicious, stern and unwelcoming. Today, they are friendly and helpful and make it obvious that they want to encourage our business partnerships. They ask for and act on feedback so they can continue to improve their service and successfully court new business investments.

Prime: Tell us about the early days of setting up your business in China.

Ellyson: Looking back, I’m reminded of how young and idealistic I was. Traveling in China was difficult at every junction. We drove ancient, beat-up Volkswagen Jettas over winding dirt roads full of potholes because there were so few paved roads. We had to constantly zig-zag around pedestrians, cyclists, push carts and livestock. It seems like I was carsick the entire time. I slept on factory floors because there were no hotels nearby. I used to take 30-40 food bars with me because I was unaccustomed to the local food and couldn’t tolerate it. I had to spend hours at night feeding documents into a fax machine to communicate with the U.S. and only on rare occasions could I pay for a factory to bring in slow, dial-up internet just so I could send and receive e-mails.

I used to see terrible working conditions in the factories and from the very beginning, we made it clear that if a factory wanted to work with us, then they would have to implement safety standards and greatly improve conditions. If the managers weren’t willing to do that, we took our business elsewhere. It was – and still is – extremely gratifying to see the improvements we were able to instigate and to know we were improving the lives of the factory workers and their families.

Prime: You don’t have to invest in China. What are the risks there for you and others and how have those risks changed over time?

Ellyson: I wasn’t completely aware of all the risks of doing business in China when I first began working there, but I thought I could figure it out as I went along. In general, the main areas of risk include environmental risks like floods and earthquakes and political disruptions that can shut down businesses and halt transportation. East West Manufacturing deals with quality risks where we have to educate and supervise the Chinese workers to ensure each and every shipment meets our clients’ quality standards. We clearly communicate and document quality expectations in advance and work closely with the factory managers throughout the manufacturing process.

The key to mitigating all of these risks is diversifying the process. For example, both environmental and governmental upheavals can disrupt a supply chain, so we have to develop multiple sources of materials and manufacturing sites. That way, manufacturing can continue without a disastrous interruption, and you can also move products around to take maximum advantage of savings – either raw material or labor costs. And by diversifying, I mean diversifying within and beyond China. There are many more options both in China and other developing countries than there used to be, offering customers security, flexibility and maximum competitiveness.

Prime: How has East West Manufacturing responded to the risks and to the changing opportunities?

Ellyson: We strategically match products to expertise, helping our clients take advantage of local production skills and strengths. We pre-qualify our suppliers on critical manufacturing capabilities, competitiveness, IP stewardship, safety and labor practices. And, most importantly, we believe in having “feet on the street.” In other words, we maintain a significant presence in each country of manufacture, whether working with sub-suppliers or a fully owned factory, to understand the local culture, negotiate the best pricing and manage suppliers’ performance.

When we manufacture over $1 million worth of products for a customer, we automatically add multiple suppliers. As I mentioned above, we have diversified both raw materials sourcing and manufacturing facilities outside of China to India and Vietnam, because I feel certain Chinese labor costs will continue to rise, and there is always a risk of political change. This year, we are working towards being able to sell products inside China, rather than shipping everything overseas, to take advantage of this emerging market. Some of our competitors are moving further west into China, but I believe it makes more sense to diversity outside of China.

Prime: One of the biggest challenges in your business must be quality control. How do you manage this? Does your strategy on quality control differ in China as compared with other countries?

Ellyson: No matter what country we are working in, it all starts by understanding what our customers’ quality requirements are and documenting those requirements in advance. From there, we work closely with the factory manager every step of the way, testing and inspecting raw materials as well as each shipment of finished product. I tell people it’s like baking a cake. The customer tells us what the cake must look, smell and taste like. We procure quality ingredients for the recipe. The factory bakes the cake. Our oversight ensures the ingredients are acceptable, the recipe is being followed and the end product – the cake – is exactly as requested. Quality assurance is built into every step of the process.

Prime: What is your favorite story from your China experiences?

Ellyson: There are so many, it’s hard to choose, but I am especially proud of how we established our office in Shenzhen, China. In the beginning, we wanted to find a Chinese engineer with the education and experience to run our Shenzhen operation. Despite an intensive search, we couldn’t find someone with our original requirements, but we found Kenny, who had the education and talent, but not the experience. We decided to take a chance with him, but as Plan B, we hired Matt, an engineer from Texas who had been living in China, studying Mandarin, and was now working for a U.K.-based manufacturer. We thought Matt could step in if Kenny didn’t work out.

Kenny more than “worked out.” He exceeded our expectations and has become a valued member of East West Manufacturing’s senior staff, and a key reason for our Shenzhen operation’s success. Matt turned out to be the perfect person to oversee our new factory in Vietnam, and thanks to him, we were able to get new facility operational very quickly. Both men have made tremendous contributions to our company’s growth.

Prime: Being in an outsourcing business, you probably are often asked why you are not manufacturing more in the U.S. What is your response?

Ellyson: We call what we do for our customers “Domestic Offshore Manufacturing.” In a nutshell, we oversee the planning, design and implementation of offshore product manufacturing for Western-based original equipment manufacturers and distributors. We marry the quality control typically found in domestic manufacturing with the cost- savings of offshore manufacturing. The model makes sense for a number of U.S.-based businesses seeking to stay competitive in their markets. It doesn’t mean we take all of their manufacturing offshore. We take some of the component manufacturing offshore so our customers can reap the benefits of the expertise available in other countries and realize cost savings. It’s not black-and-white or all-or-nothing in manufacturing, meaning many products are manufactured in one or more locations and assembled elsewhere. Take cars for example. Even the ones touted as “American made” have components manufactured all over the world. The final assembly takes place in the U.S. The same is true with computers. China is where most circuit boards are now manufactured and then shipped overseas for final assembly. Maybe down the road, East West Manufacturing will set up our own manufacturing facility in the U.S. for final assembly. In the meantime, because of what we do, our customers are able to competitively price their products and grow their market share.

Prime: What should policy makers in the U.S. do to improve the domestic environment for manufacturing and for business more generally?

Ellyson: In my opinion, we’ve completely lost our way in terms of attracting manufacturing to the U.S. Taxes are the biggest culprit. The United States levies the highest corporate taxes in the world and fails to incentivize investment at the federal level. Compare that to any other industrial country trying to attract manufacturing. For example, if I go to Vietnam and China, I pay zero tax for the first five years and half the corporate rate for the next five years. Here at home, I pay almost 40 percent in taxes from day one. When you start a business, those early years are crucial and taxes take a huge percent. How can we expect people to begin businesses when the tax burden is so high? We could overcome the high labor costs in the U.S. if we could reduce taxes and regulations. The other thing that has to happen is healthcare reform. Healthcare costs severely impact businesses. In our own company, our healthcare costs just increased 20 percent this past year, which is a big deal for our bottom line. Everyone talks about labor costs in the U.S., but the reality is that healthcare costs are going up more than labor costs.

As for innovation, we must improve our regulatory and government agencies like the U.S. Patent Office. In China, the average lead time to obtain a patent is two-to-three years. In the U.S. the average lead time is eight-to-nine years. That sort of bureaucratic red tape discourages innovation, rather than supporting and encouraging it. One of our engineers may come up with a great idea to improve efficiency, but if I know it will take up to nine years before we have intellectual property protection via patent approval, I am not going to move forward with the idea.

Prime: Do you think it is likely the U.S. will take these steps?

Ellyson: Not anytime soon. Sadly, I believe things have to get even worse before we take the necessary actions to make them better. I don’t think these are political issues, I think they’re incompetence issues. It’s as if our political leaders are only looking at short-term ideas to solve long-term problems. For example, the new jobs bill recently proposed by the president is full of immediate, short-term recommendations. Those of us running a business have to think long-term, and I don’t see that happening in our government.

Another problem is the divisiveness of our elected officials. I don’t remember ever having such a polarized Congress. I think the citizens of this country are tired of all the bickering and want our elected leaders to work together to solve the serious economic issues the U.S. is facing. At the same time, we seem to be blind to our competition. We’re not taking note of what other countries are doing to obtain and maintain a competitive advantage. Instead, we’re distracted by wars, debt, joblessness and immigration issues and are taking our focus away from business productivity.

Prime: I have heard you argue that the U.S. needs to maintain some manufacturing in order to ensure innovation. What is the connection and why is this so important?

Ellyson: If you disconnect yourself entirely from manufacturing, you become removed from the processes that stimulate innovation. Ideas for how to make things better, faster and cheaper come from people who work day-to-day in manufacturing.

Prime: Although manufacturing’s share of employment has fallen substantially, the U.S. still has a large manufacturing base in terms of value. Is a large value base—if we maintain it—sufficient to support innovation from your perspective?

Ellyson: No, it is not. We need to become more creative to attract more manufacturing here. Every manufacturing job creates service sector jobs like dry cleaning, grocery stores, and so forth. The reality is we are in a competitive global market. China is going after our high-tech industry, for example. It’s not enough to hang onto the research and development functions. Look at Apple. They have around 50,000 employees designing their products, but they sub out the manufacturing of those products to another company with a million employees. That tells me it takes a million people to make what 50,000 people design. So, you can’t create enough jobs with just R&D. You have to hang on to the manufacturing, too.

Prime: Do you see Chinese companies as primarily competitors, or as cooperative partners in a global production networks that help create value for everyone?

Ellyson: They’re both and we’re shifting from one to another. We’re moving from a cooperative base that supports many multi-national companies to a competitive environment. Chinese companies created their foundation by serving as our suppliers, but now they’re going to be aggressively looking for brands to own that will compete against our brands. The Chinese want the same success we’ve had and they understand you’re not going to get there by making products for other companies.

Prime: Any final thoughts?

Ellyson: You often hear that China is unfairly manipulating its currency. In some respects this is true, but at the moment I don’t think it is undervalued. Most people don’t realize that just a few years ago, China’s currency was trading at 8.78 Yuan to the U.S. dollar and now it’s at 6.38. That’s a shift of nearly 30%. Even if the currency moves another 15-20 percent to the dollar, it’s not going to have a major impact on our trade imbalance. If anything a higher currency will just push more manufacturing to other lower-cost countries.

It’s true that China exports more products to the U.S. than it imports from us, but the reverse is true for China and the rest of the world. In total, China consumes more than it exports. Nevertheless, a lot of people are calling for taxing products coming into this country from China. Well, guess what? China is not the cheapest country for manufacturing any more and if we start taxing them, do you really think companies will move their production back to the U.S.? No – they’ll go to Vietnam, Indonesia, India or another low cost country. The only thing taxing products from China will help is in creating a trade war, which we definitely don’t need right now.

China is evolving and we’ve got to find ways to work together. Here at home, we should be focusing on high tech products (like bio and energy) that aren’t as sensitive to labor costs and incentivize manufacturing so we can compete in the new global reality. We must implement long-term programs like permanent R&D tax credits, lower corporate taxes, elimination of capital gains and Sarbanes-Oxley, reduced healthcare costs, faster patent processes and stopping the “brain drain” to other countries.

Let’s not view China as a threat. Instead, let’s look at China as a partner with whom we can make positive changes.

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