The Fun Parts

In the last post I mentioned pricing as the least fun part of my job. For a little balance I thought I'd share what is the most fun. Here goes in no particular order:

• The OPSA Team - We really have a great group. I wish I was closer to the office so I could be there more often. I get there about once every six to eight weeks and it's always great to be there.
• Our Customers - The great majority of my customers are great to work with. Most are very intense when it comes to getting the best deal for their companies' and are fun to be with and get to know.
• The OPSHK Staff - I haven't been to Hong Kong in a while and I feel a bit detached. When I'm there the group is pretty much all business, although I have seen them loosen up a bit. My family had a great time when we had lunch with the staff during our March 2006 trip to HK and Beijing.
• Travel - I get to travel to some fun places and have great control over when I travel. When I left my corporate job I thought I'd miss all the nice hotels and resorts at industry events, but I really don't at all.
• Flexibility - This business offers great flexibility. In fact, I work as much late at night and early in the AM as I do during the midday.
• Variety and Learning - Working with many different kinds of businesses and on many different products I am really learning a great deal about manufacturing. I'm not an engineer, and I've never played one on TV, but I'm picking up lots of the lingo and can talk pretty intelligently about all kinds of tooling, materials, drawings, and processes.
• Small Company Culture - Although we've grown quite a bit the last few years, we are still a pretty small group. It's great to know everything about the business and to make decisions about where we're going and how we'll get there.
• Cool Factor - I must admit that I like the cool factor in what we do. More than half our company is in China for goodness sakes.

That's most of the fun points. As you see they swamp the one or two difficult things.

Price Factors Frustrate

Since the start of 2007 pricing has been the least fun part of this job. Prices are up across the board for products from China and they show no sign of going the other direction anytime soon. Here are the main factors impacting prices:

1. RMB exchange rates. The RMB is up 10.3% since the beginning of 2007. Back then a USD was worth 7.8RMB. Now you only get 7.0RMB per dollar. The Chinese government is giving in to international pressure to let the RMB rise (although it's been stable against the Euro over this same time) in value, and also is using monetary policy to advance their initiative to slow economic growth to control inflation.

2. Metal prices were up significantly in 2007. This actually started in 2006 and is mainly caused by increasing demand for metals as the economies of China and India rapidly expand.

3. Oil prices are up from $60 per barrel at the start of 2007 to over $100 per barrel today. This is a painful impact on transportation costs and on materials like plastics and synthetic rubber compounds.

4. Labor costs are up sharply. As Chinese workers increase their income they become less inclined to travel away from their families for 11.5 months to the factories in Guangdong province and around Shanghai. Plus, on January 1, 2008 China's new labor laws went into effect. These new laws offer needed protections for workers, but also serve to increase costs.

5. VAT refund changes took effect in 2007. Manufacturers in China pay VAT taxes on supplies and materials they purchase in China. Before the changes, manufacturers that exported could get large refunds of these taxes. In 2007 the government eliminated many of these refunds as another way to slow economic growth.

6. New regulations and cash flow requirements on importing materials took effect in 2007. In another effort to slow the economy and promote trade balance the Chinese government now requires large deposits be held by China Customs when manufacturers import raw materials. If the materials are not used up in a certain period of time, Customs keeps the deposit. This cash flow impact will require more borrowing which increases costs and prices over time.

I'm looking forward to getting back to some price stability, but we're advising our customers to expect more increases until we see some evidence to the contrary. Unfortunately I expect to post more on this going forward.

Chinese Education Survey

As a school board member in our community I am very attuned to education news. I read an interesting article today at China Daily.

http://www.chinadaily.com.cn/china/2008-03/25/content_6561947.htm

Essentially the survey found that 40% of Chinese respondents feel their educational system is not returning an appropriate return on the investment they are making in it. This is very interesting as the media in the US is frequently reporting that the US is falling behind countries like China and India in education. This article shows that comparisons of educational systems are very complex.

Another interesting note from the article - many respondents seem to be measuring the return on education based on their salary versus their salary expectations given their level of education. This highlights the stress I see in China as folks believe they should be earning more.

So, what's the point? First, the US educational system needs to keep improving, but not using the Chinese model as a guide. I continue to believe it is too focused on testing achievement on not focused enough on preparing students for their future. Second, the Chinese education system is still not producing management talent and their economy will continue to import expertise for a while at least. This leads me to believe OPSA continues to be in a great position to help our customers and the factories by providing a safety net layer of project management.

OPSA's Open Business Model

One of the things that makes OPS America different from many of our competitors is our open business model. We freely tell our customers which factories we use for them. We also encourage our customers to come to China and visit our offices and the factories. We also open communications for our customers directly with our project managers and others in our Hong Kong office.

We realize that since we don't tie our customers to us with contracts, that our open model raises the risk that a customer may try to contact a factory and work directly with them. In practice however, this just doesn't happen. When customers come to China and see all we do to ensure their success with Chinese manufacturing they realize it doesn't make sense to try and do it themselves.

An open model is easier to manage and more fun. We don't intend to change.

Freight Gone Wild

Freight costs have been extremely volatile, mostly in the increasing direction. Here are a couple of factors:

- Believe it or not, there is an equipment imbalance with a shortage of containers for export. With the weakness in the US economy and weakness of the US dollar, exports are surging while import growth has slowed. Any imbalance causes increased costs for carriers as they must move equipment around. This eventually gets passed on to shippers.

- Fuel costs - no need to say any more about this

- Overcrowding of US ports on the West Coast

- New security requirements

- New environmental regulations. One interesting one is the new California rule that trucks made before 1988 will no longer be able to carry freight from ports. This raises costs as trucking companies need to replace equipment.

So, freight in both directions is getting more expensive. Hopefully this is the peak of costs and we can see some relief in the future.

Chinese Companies Become Multinationals

There was an interesting article in USA Today recently on Chinese firms establishing locations in the US and other countries. Here is the link:

http://www.usatoday.com/money/world/2008-03-16-chinarising_N.htm

The benefits are obvious. They can still utilize their cost advantages back in China, but be in their target markets for faster response time and to learn how to market. The main weakness keeping Chinese companies from being able to market in the US like Japanese companies do is lack of marketing expertise. As they move out of China, these companies will learn western marketing practices.

This will be another factor in China improving its IP protection. As its own companies start branding, the Chinese government will get more and more motivated to begin protecting intellectual property.

There is nothing but good news in this development.

No Problems = No Business

In the January 2008 issue of Inc. Magazine George Naddaff, the founder of Boston Chicken, is quoted saying, "No business, no problems. No problems, no business. Problems are opportunities".

At two meetings today in the Northeast I was asked if the recent quality problems with pet food and toys from China have affected our business. I responded that we are viewing it as an opportunity. Small and mid-sized companies still want and need to be in China. With the recent news we believe they are realizing they need a presence "on the ground" in China to be their eyes and ears. We provide the infrastructure and "on the ground" presence to greatly reduce the risk related to manufacturing in China.

Now, I wouldn't mind at all if the material price increase problems we are dealing with went away. I'm still looking for the opportunity in that one.

Chinese Trade Surplus Falls

An article in USA Today reports on the large drop in China's February trade surplus. The great news is that imports from the US increased 31% for the month.

http://www.usatoday.com/money/economy/trade/2008-03-10-china-trade_N.htm

The rise of the RMB versus the US dollar seems to be the main driver of the changes. Also, the February storms surely had some impact on Chinese exports.

At OPSA we've discussed starting a new division or business to help our clients and other companies begin selling in the Chinese market. Like in our current business, there is lots of competition in that business. However, with the exchange rate going the way it is now may be the time to start working on it.