VP Supply Chain Research Stan Aronow and I were just discussing the recent devaluation of the yuan (RMB). According to Stan, a key question to consider is how wide the band of movement for the currency exchange will be over time since small changes probably won’t impact global trade flows or manufacturing location strategies. After a while though, there are tipping points that would be reached, and this is where the impact will be felt.
We talked about how the devaluation of the Yuan (RMB) has impacts on both the demand and the supply side for many companies. From a macroeconomic perspective, products sold in Chinese currency become cheaper for those buying them in dollars, euro, pounds and yen. This should increase exports from China and conversely put downward pressure on imports as non-Chinese goods become more expensive for them.
From a microeconomic perspective, Stan suggests drilling down into specific product categories to assess expected changes in demand based on consumer price sensitivity (elasticity). Consider that luxury goods from France might sell just as well if they are 10% more expensive than at today’s conversion rate. On the supply side, labor costs have been growing in China. The labor inflation rate has been 15-20% over the last several years, which has made it more expensive doing business there, so the recent devaluation has an offsetting impact.
If you look at the impact on Chinese-made products, you also need to consider what changes in costs will get absorbed by local contract manufacturers versus non-Chinese brand owners. Using Apple and Foxconn as an example, if Apple buys using dollars, they would likely renegotiate for a lower unit cost if the RMB devalued enough since local labor is now cheaper in dollar terms. As a hedge, Stan suggests having clauses built into sourcing contracts that allows trading partners to initiate renegotiation if the underlying exchange rate moves outside of a prescribed range.
Another factor to consider is how labor intensive your China-sourced products are. You would need to go through your bills of materials to assess impacts. If you look at the cost of goods sold for iPhones and iPads, for instance, the manufacturing labor component would actually be in the single digit percentages. Now would that impact the price point they’d sell products to end users, Stan questions? Likely not, that would become more profit in most markets. The exception would be where they are selling their products in the Chinese market. Likewise, Stan noted in a recent Wall Street Journal article that Chinese-based manufacturers could see the opposite effect. If Chinese phone maker Xiaomi is buying semiconductors from Qualcomm in dollars for instance, they would be paying more in local currency terms, but also be challenged to pass the additional cost on to price-sensitive Chinese customers.
So Stan, last question: why would a company move the location of its manufacturing to or from China based on changes in the RMB exchange rate?
• A lower total landed cost is one reason, but there are other strategic factors to consider, such as reliability and quality.
• Moreover, would a new location have an ecosystem of suppliers nearby to quickly collaborate with on new products and to have agile supply capability for existing products?
• Some brand owners have manufacturing partners with locations in China and other low cost source countries. In this scenario, the production mix between sites might change more readily, based on large currency exchange shifts, than for a brand owner with in-house manufacturing.
• There are many other strategic considerations for a shift in shoring strategy, with a critical one being protection of intellectual property. Case in point, we just read about an aesthetically knocked-off Land Rover SUV selling in China for about $30,000 versus the roughly $80,000 price for the original product.
This is why we love Supply Chain. A currency shift or a move in oil prices gives us so much to discuss. What are your thoughts? How is this impacting your Supply Chain?