China: Ready For the Next Sourcing Wave?

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The 2005 World Investment Report from the United Nations Conference on Trade and Development (UNCTAD) indicated that Western multinationals already had established more than 700 research and development facilities in China. The number continues to increase with each passing day. Hewlett-Packard (HPQ) opened its HP Labs China this past November. Other U.S. companies with major R&D facilities in China include DuPont, General Electric (GE), General Motors (GM), IBM (IBM), Intel (INTC), Lucent Technologies (LUTHP), Microsoft (MSFT), Motorola (MOT), and Rohm & Haas (ROH).

Though exact numbers are not easy to pin down, the Organization for Economic Cooperation and Development (OECD) estimated last year that China in 2006 would become the world's second-highest investor in R&D after the U.S. Using purchasing power parity as its measure, OECD estimated that the U.S. would spend $330 billion on R&D, China $136 billion, Japan $130 billion, and the EU-15 a combined $230 billion.

Wave 3.0: China as global center for procurement

Today's China is the center of an economic maelstrom that grows larger and more powerful (and increasingly complex) every day. R&D centers originally set up to support product localization for the Chinese market are now going full force in developing new products for the global market.

These rapid changes, which will continue to accelerate, mean that many Western companies have to rethink their global procurement operations. The announcement that IBM is moving its global procurement headquarters to Shenzhen is the most visible sign that sourcing wave 3.0 is underway—with China becoming the global center for procurement.

This is especially true for electronics, where the combination of low cost R&D capabilities, and deep multi-layer networks of electronic suppliers clustered together, has turned China into the dominant global electronics hub. IBM is not an isolated case. In the automotive industry, for example, General Motors has relocated its power-train electronics procurement offices to China. Other companies and industries will follow suit.

As part of our ongoing work, The Boston Consulting Group recently benchmarked the China sourcing operations of leading multinationals. We found that most companies continue to realize significant savings by sourcing in China. However, we also found wide variations in performance among the companies. While some companies excel, most have significant room to improve. Many are still struggling with sourcing 2.0; only a few have started to come to grips with wave 3.0.

China will not, and should not, become the center of global procurement for every company. China may not be the best location for some goods as other countries, such as Vietnam, take their place in the global supplier food chain. Not every company has to ride wave 3.0 in China. However, given the continued evolution of China sourcing and the wide range of performance we observe among China sourcing offices today, a prudent step for most companies would be to ensure that their sourcing operations are where they should be, to fully leverage China and other RDEs for global advantage.

Jim Hemerling is a senior vice-president and Shanghai-based managing director for Greater China at Boston Consulting Group. He holds bachelor's and master's degrees in engineering from the University of British Columbia and an MBA from the Richard Ivey School of Business. He is a columnist for Asia Insight.