by Etienne Charlier
Everybody knows that China manufacturing benefits from lower labor costs , even though it is currently eroding. But another cost advantage is less understood: Continuous product cost reduction by redesign.
Product cost reduction
Product cost reduction by redesign means that a manufacturer changes one aspect of the product without changing its functionality but in a way that reduces production cost.
Most manufacturers across the world will have such cost reduction processes, formally or informally:
All companies will have two constraints in this cost reduction by redesign process:
Chinese manufacturers have a serious advantage compared to Western vendors, because the cost of Chinese technicians and engineers is much lower than in the West. A Chinese engineer will cost almost 5 times less than a Western engineer.
How does this play out? Let us take one product for which 10 cost improvement ideas could be implemented over one year. Each idea generates a product cost saving between 0.5% and 3% . Implementing the idea will have a one time cost of 2 to 10 persons a year.
A Western manufacturer will only be able to catch half of the cost reduction. Some of the ideas will be rejected because the business case for small saving is negative. Implementation of some ideas with positive business cases will be postponed to next year because implementing the top saving ideas eats up the available budget.
At the same time, the Chinese company will conclude that all ideas have a positive business case and the same R&D budget gives it enough manpower to implement all ideas within the year.
Each project leads to the some cost reduction but Chinese companies will be able to implement more of them.
Allocation of R&D budget for each approved cost reduction project.
In this illustration, the Western company will reject a third of the cost reduction ideas and will be able to implement only 2 ideas within the year. It will be able to generate a 5% cost reduction out of a possible 7%.
The Chinese supplier will implement all the 10 ideas and generate a 10% saving within the year.
When the two companies start the year with the same cost base, the Chinese company will end the year with a product 5% cheaper after one year. If this game continues for several years, the Chinese company will accumulate cost advantages, unless the Western company comes up with a drastically innovative idea.
The table below shows how strong the cumulative effect of this R&D cost advantage can be.
This illustration is simplistic in order to demonstrate the mechanism at play. But do not think that this is academic. This is playing in the real world.
I have done it myself with real products. In the most successful case, I have led a team of people in China that secured a yearly 30% cost for each of several consecutive years for a professional electronic system. The 30% resulted from adding up several tens of cost improvement ideas, most of them generating rather small savings.
The advantage of Chinese suppliers in driving product costs down is very strong. Smart purchasers will use this to their advantage and will actively manage this process:
Only purchasers with strong organization and working with strong suppliers will be able to do this. But those create sustainable advantages.