Low-cost country sourcing
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Low-cost country sourcing (LCCS) is procurement strategy in which a company sources materials from countries with lower labour and production costs in order to cut operating expenses. LCCS falls under a broad category of procurement efforts called global sourcing. The process of low cost sourcing consists of two parties. The customer and the supplier countries like US, UK, Canada, Australia, and West European nations are considered as high cost countries (HCC) whereas resource rich and regulated wage labor locations like China, India, Indonesia, Bolivia, Brazil, Russia, Mexico, and East European nations are considered low cost countries (LCC). In low cost country sourcing the material flows from LCC to HCC while the technology flows from HCC to LCC.
The primary principle behind LCCS is to obtain sourcing efficiencies through identifying and exploiting cost arbitrage between geographies.
Labour costs has been rising across Asia as Asians now are more willing to pay a premium for the products and services they receive and thus causing production cost to increase. Many countries in Asia have seen a rapid rise in wages since the late 2000s. One factor contributing to the wage rises is due to the shift of labour from agricultural work into more productive jobs in industry, labour productivity has increased quickly thus leading to wage growth. Workers will demand for better wages as Singapore's economic growth and living costs are gradually increasing. Businesses will thus face pressure on their profit margins as rising labour costs leads to higher production costs.
The labour costs in China and India has been increasing over the years. China was initially one of the lowest labour costs known to other countries. However, due to the rising demands of people and the increase in the cost of goods, China is no longer regarded as the ‘cheapest’ country to manufacture goods anymore. China is now deemed as less competitive compared to other countries. The increased labour costs have resulted in some foreign firms exiting the country, in search of countries whereby the labour cost is cheaper. Thailand and Philippines are some of the countries that are able to provide cheaper labour costs. This would mean that manufacturing in China will not be the cheapest place to do so anymore. Furthermore, as some other countries apart from China are beginning to provide raw materials at a lower cost, many manufacturers are able to have more choices of purchasing raw materials needed.
Wages have been pushed up by long-term decline in the aggregate labor force, combined with a rapid depletion in rural surplus labor, which has until recently provided an ultimate source of cheap labor," said the report.But it warned that the massive reallocation of labor "from low productivity agriculture to higher productivity manufacturing is coming to an end".Even before the Chinese economy started to turn down, there were concerns that it was facing a middle income trap, widely identified by economists as showing the danger of a Lewis Turning Point - a phenomenon identified by the economist Arthur Lewis in the 1970s from research done on the economic history of Japan, which showed that rapid urbanization led to a growth in manufacturing, which in turn brought faster economy
However, eventually, the phenomenon comes to an end as wages rise and the country's competitive edge disappears, says the Lewis idea.The latest E&Y report said the number of migrant workers in China has been increasing at a slower pace since 2005.It added that although there are 320 million laborers still in agriculture, only 20 million have the potential to migrate to cities, pushing the country to a point at which "the excess labor in the subsistence sector is fully absorbed into the modern sector, and where further capital accumulation begins to increase wages" - pointing to a classic Lewis scenario. Simon Benjamin, a partner with E&Y advisory services, said the labor shortage is not yet a major problem in China, as there are still measures the government can take to free up the pool of rural labor, such as the further easing of the hukou, or household registration, system. “However, these are unlikely to reverse the trend of increasing labor costs," he said. They will continue to rise as minimum wages and social welfare improve, Benjamin said, adding that on top of the 13 percent annual increase in the minimum wage as set in the 12th Five-Year Plan (2011–15), mandatory social welfare will add another 35 to 40 percent to the payroll cost.
"Rising wages are most significant to primary producers and services industries, as labor takes the major share of total costs in these sectors," Benjamin said.Apart from labor, capital - still relatively cheap in China - will also become more expensive as policymakers move the country toward interest rate liberalization, the report said. Material costs, too, will continue to rise and will reach global levels, it added.Commodities prices in China have increased 51 percent in the last five years, and energy prices were up 77 percent, it noted.And last but not least, as the economy slows down, it has become harder and harder for companies to pass on the costs to customers.
Not necessarily all "low cost countries" are destinations for LCCS. Only those countries with relatively stable politic and economic environment, modern infrastructure and acceptably compatible legal system are considered to be ideal for sourcing. Examples and most popular regions are China, Indonesia, Thailand, Vietnam, Malaysia, Etiopia, India, Ukraine, Romania, Bulgaria, Mexico, Bolivia, Cambodia, Hungary and Czech Republic.
In 2000, Mexican manufacturing labor was more than three times as expensive as Chinese. But after of decade of stagnant wages in Mexico and a sustained rise in China, Chinese labor is no longer cheap. In fact, it costs almost the same amount to hire Mexican workers, JP Morgan economists write. That turnaround—along with other factors, such as the surging costs of transporting finished goods in recent years—helped drive Mexico’s share of US manufacturing imports to nearly 15% in 2012, up from a 10-year low of 11.2% in 2005. Along with a yuan that remains quite strong by the standards of the last two decades, the rising cost of Chinese workers is another headwind for the export sector in the People’s Republic. On the flip side, those workers’ rising wages have helped make consumer spending in China a bit more resilient. For instance, retail sales bounced a better-than-expected 14.2% in September, compared to the prior year. That’s a welcome sign for those hoping to see the global economy emerge from the Great Recession with more balance between emerging-market producers and developed-market consumption. China's rising labor costs will help other South Asian countries gain a foothold in low-end manufacturing, a report from Capital Economics said on Thursday.
"Although many countries can now compete with China on labor costs, it is countries elsewhere in Asia, able to take advantage of strong infrastructure and existing supply chain networks that will be the main beneficiaries of China's move out of low-end manufacturing," said Gareth Leather, an economist at independent research firm Capital Economics. (Read More: Cambodia Benefits From Rising China Wages) China remains the world's largest exporter of low-end goods, but has recently started to lose share in key markets such as textiles. Leather singled out Vietnam as particularly likely to gain from a fall-off in China's dominance, due to its low wages and stable political scene.
"Moreover, given its proximity to China, Vietnam is able to benefit from existing supply chains," he said. While Vietnam's labor costs are currently half those of China's, they are rising quickly. "The global textile industry is notoriously footloose, and it may not be long therefore before suppliers look for alternatives," Leather added. Outside of Asia, few countries stand to benefit substantially from China's rising costs, according to Leather. While, emerging Europe has the advantage of proximity to the European Union, it is hampered by relatively high labor costs. In Africa, the reverse situation exists, with a thriving textile sector in countries such as Mauritius, but less developed supply chains. Mexico meanwhile benefits from proximity to the U.S., but suffers from low productivity growth. Leather added that losing out on low-end market share would not prove a "big deal" for China.
"The change reflects a shift by Chinese producers into sectors where margins are higher, such as digital products and automotive components, rather than a failure to compete." December's trade data from China showed an uptick in exports, which increased 14.1 percent year-on-year, the fastest rate in seven months.
However, earlier this week, analysts told CNBC that rising labor costs in Asia posed a risk in the form of upward pressure on inflation. "Everyone thinks inflation is not an issue right now, but it is going to make a come-back and while in the past inflation has been all about food and energy, this time it is going to be about wages, and that is a much more pernicious threat," Frederic Neumann, the co-head of Asian economic research at HSBC, said.