Background:
Client was a Western industrial manufacturer with a manufacturing plant in China. This facility supplied Western clients in Asia for approximately 6 years, and had a limited but growing list of domestic Chinese clients. Due to changing customer needs in China, the company either had to add new equipment at the factory or subcontract the production to other Asian manufacturers. Their existing equipment could not meet all the product modifications requested by their clients.
The company had made the initial mistake of not developing a lean manufacturing operation which could be more cost effective with Asian suppliers. Thus, they had spent too much money establishing and managing the facility. For example, they overpaid for foreign equipment, had an unusually high number of Western expatriates on Western salary structures and compensation packages for their sales teams which far exceeded those of their competitors.
When the company was initially gathering information on the China market as part of their Market Entry strategy, they obtained poor information on the China market, specifically their competitors, price points for different industrial products, product segmentation in the marketplace, etc. Their original business plan stated that in their first 3 years of operation, the company would be selling 50% of their product to domestic Chinese clients.
However, their fixed costs were too high to be competitive with domestic Chinese firms and their sales to Western clients in Asia had decreased due to the tough economy.
The client was importing European raw materials into China and paying Tariff/Duty/Quotas (TDQ) and Value-Added Tax (VAT) on the imported product. Using the imported raw material, the company manufactured finished goods and shipped to the US. Upon shipment of finished goods, the client would apply for a VAT rebate.
Client was losing money at the Chinese facility. East West was engaged to conduct the Global Strategic Initiative and quickly assist the company in restructuring their global business model to stem the financial losses.
Challenge:
The initial challenge was to reduce the operational fixed costs and move to a more variable cost model to be more competitive with Western and domestic Chinese competitors - this strategy would allow for greater flexibility in economic downturns.
East West needed to develop a supply chain strategy to avoid initial payment of TDQs and VAT because re-imbursement from the Chinese government was slow and affected cash flow. Lastly, it was important to the client to maintain product development capabilities in China because 24 hour cycle was very efficient.
Solution:
East West recommended and performed a multi-step approach:
- Advise client to use the 'toll manufacturing' approach and establish a bonded warehouse in Shanghai. Since this warehouse not considered part of the China, our client could avoid VAT payment. We established relationships with the local customs office to match the imported raw materials with a finished goods order. Customs was able to correlate the raw material product in the warehouse with a specific finished goods order being shipped to the US. This method allowed client to avoid VAT.
- East West identified and qualified multiple raw material and finished goods vendors in China and other Asian countries. We developed a prioritized list of primary vendors and a secondary alternative list of qualified suppliers. The client was able to have their product manufactured using variable costs from qualified vendors.
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Because the manufacturing operation had high fixed costs and did not have the proper equipment to meet the changing product needs, we proposed a thorough Assessment of their Asian operation in order to make a number of changes to reduce their cost structure. These changes included identification of lower-cost vendors, elimination of non-productive personnel, restructuring compensation packages, introduction to qualified distribution firms with close relationships with potential Chinese customers, and elimination of non-revenue producing product lines to re-focus on other market segments.
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As part of this Assessment, East West developed a market assessment for the client which provided specific information on competitors, distribution channels unknown to the client, pricing and product portfolio information.
Result:
East West presented these recommendations to the senior management in the US and their Board of Directors. The client has chosen to accept the East West proposals and the relationship is ongoing. Based on our experience successfully managing businesses in Asia which can compete with Chinese companies, our Assessment identified a number of cost-reduction changes and we are currently implemented them.
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