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How Rising Wages Are Changing The Game In China


For years, Yongjin Group has earned a decent profit selling lamps and furniture to the likes of Wal-Mart (WMT), Home Depot (HD), Target (TGT), and Pottery Barn. But lately the company has seen its margins shrink to 5% -- half what Yongjin made when it opened its factory in the steamy southern Chinese city of Dongguan 14 years ago. Why? Labor shortages are forcing the company to boost wages. Last year salaries surged 40%, to an average of $160 a month, and Yongjin still can't find enough workers. "This business needs a lot of labor," says President Sam Lin. "This is a very tough challenge."

Some 1,500 miles northeast, in the city of Suzhou, Emerson Climate Technologies Co. is facing similar woes. The maker of air conditioner compressors has seen turnover for some jobs hit 20% annually, and Emerson General Manager David Warth says it's all he can do to keep his 800 employees from jumping ship to Samsung, Siemens (SI), Nokia (NOK), and other multinationals that are now operating in the tech manufacturing hub. "It has gotten to the point that we are just swapping folks and raising salaries," says Warth.

Wait a minute. Doesn't China have an inexhaustible supply of cheap labor? Not any longer. From the textile and toy factories of the south to the corporate headquarters and research labs in Beijing and Shanghai, the No. 1 challenge today is finding and keeping good workers. Turnover in some low-tech industries approaches 50%, according to the Institute of Contemporary Observation, a Shenzhen labor research group. Guangdong Province says it has 2.5 million jobs that remain unfilled, while Jiangsu, Zhejiang, and Shandong provinces say they, too, face shortages of qualified workers. "Before, people talked about China's unlimited labor supply," says Zhang Juwei, deputy director of the Institute of Population & Labor Economics at the Chinese Academy of Social Sciences in Beijing. "We should revise that: China is facing a limited supply of labor."

Reports of labor shortages first cropped up in late 2004, but companies thought the phenomenon was temporary. Now a surge in both turnover and wage costs is convincing multinationals and their suppliers that the China game is changing permanently. With the gap between wages in China and those elsewhere gradually closing, the pressure to pass price increases on to consumers in the U.S. and other markets will start to build. As Citigroup (C) noted in a February report: "The continuous growth of labor costs in China, even at a moderate pace...is likely to have implications for inflation worldwide." These factors eventually will force the Chinese to upgrade their entire industrial base to make higher-margin goods. And those bigger paychecks are building a consumer class in China that multinationals want to target.

"THERE IS A BREAK POINT"

The wage issue has started to affect how companies operate in China. U.S. corporations and their suppliers are starting to rethink where to locate facilities, whether deeper into the interior (where salaries and land values are smaller), or even farther afield, to lower-cost countries such as Vietnam or Indonesia. Already, higher labor costs are beginning to price some manufacturers out of more developed Chinese cities such as Shanghai and Suzhou. "There is a break point where people will say this is too expensive," says Michael Barbalas, general manager at the Suzhou plant of Andrew Corp. (ANDW), a Westchester (Ill.) maker of wireless networking gear. At his factory, he says, wages have been rising by 10% annually.

This is a slow process, to be sure. Imports from the mainland have yet to fuel inflation in the U.S., while improved productivity in China has so far offset higher wages. But economists say those productivity gains are getting harder to find, and manufacturers who are seeing their margins hit, such as Yongjin, can hold out for only so long before they have to try to raise prices.

The pressure has as much to do with skills as it does with numbers. Although the total labor force is about 800 million, relatively few people have the qualifications employers want. For most textile, toy, and tech-assembly jobs, for example, export-oriented manufacturers prefer women from 18 to 25 years old or people with experience operating machinery. "The skills base does not meet the demands of a rapidly growing market," says C.P. Lee, Asia-Pacific human resources chief at Motorola Inc. (MOT), which has 9,000 employees in China.

As a result, companies across the board are feeling the squeeze. Last year turnover at multinationals in China averaged 14%, up from 11.3% in 2004 and 8.3% in 2001. Salaries jumped by 8.4%, according to human resources consultant Hewitt Associates LLC. And a January report by the American Chamber of Commerce in China found that rising labor costs have pinched margins at 48% of U.S. manufacturers on the mainland. "China runs the risk of losing its advantage" of cheap labor, says Teresa Woodland, an author of the report.

That means managers can no longer simply provide eight-to-a-room dorms and expect laborers to toil 12 hours a day, seven days a week. When 30-year-old He Maofang first arrived in Dongguan in 2000, for instance, "work was hard to find." But now "there are plenty of choices," says He, who started at Yongjin last June. In addition to boosting salaries, Yongjin has upgraded its dormitories and improved the food in the company cafeteria. Despite those efforts, its five factories remain about 10% shy of the 6,000 employees they need.

Many companies are compensating for the shortages by penetrating deeper into China's vast heartland, where wages can be half what they are on the coast. General Motors (GM), Honda (HMC), Motorola, and Intel (INTC), for instance, have all shifted some manufacturing or research to inland locations in recent years, both to tap lower costs and to open up new markets. But a two-year-old effort by the Chinese government to lift rural incomes through tax cuts is keeping some potential factory workers on the farm. So with investment growing in the interior, labor shortages are popping up there, too. "More and more multinationals are looking for opportunities in second-tier cities," boosting salaries there faster than in the traditional manufacturing strongholds farther east, says Jean Lin, head of the compensation practice at Hewitt.

BETTER TRAINING

The trend goes beyond the factory. Only about 10% of Chinese candidates for jobs in key areas such as finance, accounting, and engineering are qualified to work for a foreign company, estimates consultant McKinsey & Co. While China today has fewer than 5,000 managers with the skills needed by multinationals, 75,000 jobs for such managers are expected to be created over the next five years, McKinsey says. The talent crunch "is the No. 1 constraint on China's growth," says Andrew Grant, McKinsey's China chief. "It will hit earlier and be more powerful than any [other] constraint," such as raw materials shortages.

Some U.S. companies in China believe better education and training is the way to stay ahead of the game. Motorola regularly hires graduates straight from school and then trains them at its "Motorola University" in Beijing. Intel Corp., which has invested $1.3 billion in chip assembly, testing, and research and development in China, has backed initiatives that have trained 600,000 teachers there. "It helps contribute to our future workforce," says Intel China President Wee Theng Tan.

LOWER ENERGY BILLS

Others are doing everything they can to retain employees. St. Louis-based Emerson has introduced flexible work hours at its Suzhou plant for workers with children. It has built a "green" office with solar power, ambitious recycling plans, and chargers for the electric bicycles used by many staffers. And to build loyalty the company holds quarterly parties for the entire staff and organizes free trips to resort areas. "I chose Emerson because it is a well-respected company," says 25-year-old Rocky Lu, who started as a technician at Emerson's Suzhou plant in February. He got a 50% raise from his last job, at a state enterprise, to nearly $400 a month.

Emerson is cutting costs elsewhere to ensure that rising wages don't price it out of Suzhou. It has lowered utility bills by raising the thermostat a couple of degrees in the summer and dropping the mercury in the winter while passing out long underwear to keep workers warm. It has added reflective light fixtures that can use lower-wattage bulbs. And it has recently tapped excess heat from its factory to warm dormitory showers. "So far it's an even trade-off" between rising labor costs and efficiency gains, says Emerson manager Warth. "We have to deal with it if we want to remain in business."

Beijing realizes that it, too, needs to deal with the issue if it wants to stay in business. So the government is further loosening rules that prevent rural residents from moving to cities to work and is offering tax breaks to overseas Chinese who return to the mainland. The higher education system is also being overhauled to include more practical classes and vocational training in a bid to expand China's skilled workforce by a third, to 8% of the population. China will still be the world's workshop. But the world will need to adjust to the inexorable rise of the workshop's wages.

By Dexter Roberts


China's Killer Profits
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