Can China Manufacturers Make the Transition from Products to Services?

Although it might seem counter-intuitive, China's manufacturing sector has emerged strengthened by the global economic downturn and the world’s factory is moving up fast on the services front as well. As I mentioned in a previous post, so says a recent report from PricewaterhouseCoopers (PwC) on the relative attractiveness of emerging markets for foreign investors.

China's manufacturing sector has shot up from 14th position in PwC's index in 2008 to become the fourth most attractive destination in 2009, beaten only by Malaysia, Chile and Bulgaria, which are all much smaller economies. Of the so-called BRIC countries -- Brazil, China, Russian and India -- China was the only one to improve its position.

This strength hides some deeper concerns in the sector. The fact is cost advantagesat Chinese factories are disappearing as more companies search for ways to create value by adding services.

Even with the current economic conditions, manufacturing in China has become more expensive. Companies reported that costs are still rising – up to 15 percent in 2008 compared to an increase of 10 percent in 2007 – particularly in compensation costs for management, support staff and blue-collar workers as well as raw materials. Although labor and raw materials costs have come down from the premium levels of last summer, they are expected to rise again once market conditions improve.

The combination of price pressures and competition brings “margin squeeze” back into the China vocabulary as profit margins begin to erode in many industries. Concerns about inflation are also now becoming more widespread as price pressures mount, says China watcher Jack Perkowski at his Managing the Dragon blog.

According to a recent article in the Wall Street Journal,

Chinese manufacturers a face rising costs as some commodity prices grow, but economists say producers may not pass on the costs to consumers because of fierce competition.

Young says Western companies will soon face a growing challenge from Chinese competitors in his fourth book, From Products to Services: Insight and Experience from Companies Which Have Embraced the Service Economy (Wiley).In a recent interview with China Knowledge@Wharton, Young noted a number of Western manufacturers, such as IBM and Unisys, have not made the transition from manufacturing to services successfully. China-based Lenovo, of course, bought IBM’s struggling PC division in 2005.

As a manufacturing economy, many Chinese seem to approach services with a manufacturing mentality which doesn't help in enhancing service levels.

China is seeing the beginning of a government-led move to raise awareness of what Young calls “the service opportunity.” Together, this spells an opportunity for Chinese companies to grow global service businesses, in addition to benefiting from an expanding domestic market.

Nowadays, with the dominance of the service sector in so many Western economies, manufacturing companies older than ten or twenty years have to ask if their traditional businesses are dead dogs, and whether they should be moving into services.From  seekingalpha