Riding the dragon - Fallows on China

James Fallows, one of my favorite writers, returned to China a year or two ago to feel the beating heart of the new world. He's digested a portion of his experiences in an essay for The Atlantic. After reading the essay, I think I understand why there's been so little response from the economists I respect to recent problems with just about everything we buy, eat and use (emphases mine):

China Makes, The World Takes, James Fallows, The Atlantic July/Aug 2007

... One facility in Guangdong province, the famous Foxconn works, sits in the middle of a conurbation just outside Shenzhen, where it occupies roughly as much space as a major airport. Some 240,000 people (the number I heard most often; estimates range between 200,000 and 300,000) work on its assembly lines, sleep in its dormitories, and eat in its company cafeterias... From the major ports serving the area, Hong Kong and Shenzhen harbors, cargo ships left last year carrying the equivalent of more than 40 million of the standard 20-foot-long metal containers that end up on trucks or railroad cars. That’s one per second, round the clock and year-round—and it’s less than half of China’s export total...

...But what is of intense interest to him, he said, is a company that has built up a brand name and relationships with retailers, and knows what it wants to promote and sell next—and needs to save time and money in manufacturing a product that requires a fair amount of assembly. “That is where we can help, because you will come here and see factories that are better than the ones you’ve been working with in America or Germany.”

Here are a few examples, all based on real-world cases: You have announced a major new product, which has gotten great buzz in the press. But close to release time, you discover a design problem that must be fixed—and no U.S. factory can adjust its production process in time.

The Chinese factories can respond more quickly, and not simply because of 12-hour workdays. “Anyplace else, you’d have to import different raw materials and components,” Casey told me. “Here, you’ve got nine different suppliers within a mile, and they can bring a sample over that afternoon. People think China is cheap, but really, it’s fast.” Moreover, the Chinese factories use more human labor, and fewer expensive robots or assembly machines, than their counterparts in rich countries. “People are the most adaptable machines,” an American industrial designer who works in China told me. “Machines need to be reprogrammed. You can have people doing something entirely different next week.”....

... You are an American inventor with a product you think has “green” potential for household energy savings. But you need to get it to market fast, because you think big companies may be trying the same thing, and you need to meet a target retail price of $100. “No place but China to do this,” Mr. China said, as he showed me the finished product...

... Casey’s PCH has a Google Earth–like system that incorporates what he has learned in 10 years of dealing with Chinese subcontractors. You name a product you want to make—say, a new case or headset for a mobile phone. Casey clicks on the map and shows the companies that can produce the necessary components—and exactly how far they are from each other in travel time. This is hard-won knowledge in an area where city maps are out of date as soon as they are published and addresses are approximate. (Casey’s are keyed in with GPS coordinates, discreetly read from his GPS-equipped mobile phone when he visits each factory.) If a factory looks promising, you click again and get interior and exterior photos, a rundown on the management, in some cases videos of the assembly line in action, plus spec sheets and engineering drawings for orders they have already filled. Similar programs allow Casey and his clients to see which ship, plane, or truck their products are on anywhere in the world, and the amount of stock on hand in any warehouse or depot. (How do they know? Each finished piece and almost every component has an individual bar code that is scanned practically every time it is touched.)...

... Even some newly built facilities leave to human hands work that has been done in the West for many decades by machines. Imagine opening a consumer product—a mobile phone, an electric toothbrush, a wireless router—and finding a part that was snapped on or glued into place. It was probably put there by a young Chinese woman who did the same thing many times per minute throughout her 12-hour workday....

... It is conceivable that bad partnerships, stolen intellectual property, dilution of brand name, logistics nightmares, or other difficulties have given many companies a sour view of outsourcing; I have heard examples in each category from foreign executives. But the more interesting theme I have heard from them, which explains why they are willing to surmount the inconveniences, involves something called the “smiley curve.”

The curve is named for the U-shaped arc of the 1970s-era smiley-face icon, and it runs from the beginning to the end of a product’s creation and sale. At the beginning is the company’s brand: HP, Siemens, Dell, Nokia, Apple. Next comes the idea for the product: an iPod, a new computer, a camera phone. After that is high-level industrial design—the conceiving of how the product will look and work. Then the detailed engineering design for how it will be made. Then the necessary components. Then the actual manufacture and assembly. Then the shipping and distribution. Then retail sales. And, finally, service contracts and sales of parts and accessories.

The significance is that China’s activity is in the middle stages—manufacturing, plus some component supply and engineering design—but America’s is at the two ends, and those are where the money is. The smiley curve, which shows the profitability or value added at each stage, starts high for branding and product concept, swoops down for manufacturing, and rises again in the retail and servicing stages. The simple way to put this—that the real money is in brand name, plus retail—may sound obvious, but its implications are illuminating.

At each factory I visited, I asked managers to estimate how much of a product’s sales price ended up in whose hands. The strength of the brand name was the most important variable. If a product is unusual enough and its brand name attractive enough, it could command so high a price that the retailer might keep half the revenue. (Think: an Armani suit, a Starbucks latte.) Most electronics products are now subject to much fiercer price competition, since it is so easy for shoppers to find bargains on the Internet. Therefore the generic Windows-style laptops I saw in one modern factory might go for around $1,000 in the United States, with the retailer keeping less than $50.

Where does the rest of the money go? The manager of that factory guessed that Intel and Microsoft together would collect about $300, and that the makers of the display screen, the disk-storage devices, and other electronic components might get $150 or so apiece. The keyboard makers would get $15 or $20; FedEx or UPS would get slightly less. When all other costs were accounted for, perhaps $30 to $40—3 to 4 percent of the total—would stay in China with the factory owners and the young women on the assembly lines....

So today, my mother can't buy a phone that works. I can, but I use research tools unimaginable ten years ago to find the one model available for sale at the moment that will work reliably for at least two years (A Panasonic phone was my last answer). On the other hand, I've given up on finding a DVD/VCR that's reliable, or a toaster that I can trust. In those cases, I just do without.

It doesn't matter, and neither do the calls I and others make for more oversight, more financial consequences. After reading Fallows one fact cannot be ignored -- we are riding the dragon, and nobody in particular is steering anything. We're not getting off until the beast is full.