Managing profitable growth has become increasingly difficult for many multinationals in China. According to recent business confidence surveys of foreign chambers of commerce in China, more multinationals experienced stagnant or decreased profit margins in 2014 than in prior years.
The country’s overall GDP growth and rapid urbanization have led to a rapid surge in costs related to human resources, raw materials, logistics, and real estate. Even though China’s economy is now expanding at a slower rate, these trends are likely to persist into 2020 and further threaten multinationals’ bottom lines.
The challenge of soaring wages
As stricter labor laws mandate higher minimum wages and larger contributions to social and housing funds, human capital in China is becoming increasingly expensive. The improved educational system has also produced higher-quality talent with greater salary expectations, and the One Child Policy will exert much more influence on the younger and more financially strained workforce in 2020. Average wages in China’s urban centers have already more than tripled since 2004, and significant growth will continue over the next five years.
(Sources: Frontier Strategy Group analysis; National Bureau of Statistics of China; ILO, IMF; PwC)
Cost hikes combined with regulatory control
Other business cost increases are also cutting multinationals’ profit margins in China. Although the country’s real estate sector is now sluggish, the property market boom in recent years has fueled spikes in office space and manufacturing site costs.
Corporate and consumer gains resulting from the oil price slump are also limited by China’s strategic oil reserves and by heavier taxation on oil products. More stringent regulatory oversight driven by environmental concerns and higher operating standards for businesses will continue to create budget pressures for multinationals.
Profitable expansion in China
As salaries in the country’s mega-cities are much higher than urban wages in key provinces, cost-effective HR solutions are still available in lower-tier cities. However, as urbanization continues, second-tier cities will gradually narrow the wage gap by 2020.
Transportation and logistics in inland cities remain a challenge for multinationals’ distribution channels. China’s urban reforms, however, encourage industry clustering and promote economies of scale and regional mobility through public transport and infrastructure projects. These initiatives will effectively eliminate lower-tier cities’ cost disadvantages in distribution management, making it easier for multinationals to expand to sub-markets in inner provinces.
Multinationals must carefully evaluate production location choices. If manufacturing in ASEAN countries proves to be cheaper than moving production to China’s lower-tier cities, then outsourcing manufacturing to lower-cost neighboring nations, such as Indonesia and Vietnam, could be a cost-saving strategy for foreign firms in China. Automation is also recommended as a way to combat rising labor costs.
Preparing multinational corporations for China’s “New Normal” through 2020
This blog post is the fourth of a six-part FSG Insight series on China’s economic outlook in the next five to six years and its implications for multinationals’ mid-term strategies. In this series, I will elaborate on some of the key opportunities and risks that multinational corporations will need to monitor as they develop their strategic positions in China through 2020. Next week’s update: “Competitive China: Threat of Local Enterprises.”