The China Syndrome and industrial distributors:
At least the asphalt plant won’t move to China

by Scott Benfield

Those of us with some maturity remember the movie “The China Syndrome,” in which a nuclear meltdown threatened the lives of millions. Industrial distributors and wholesalers who sell to industrial manufacturing are undergoing their own version of the China Syndrome and, hanging in the balance, established distribution businesses must move quickly to miss the “fallout.”

Unless you’ve been living under a rock, you will recognize the rise of China as a country of seemingly unlimited industrial prowess. Due to a huge labor force, newly opened markets, a stable and increasingly sophisticated infrastructure, and a government committed to industrializing, China has emerged as the place for manufacturing plants to move to. 

The evidence of China’s rising manufacturing prowess and the movement of U.S. factories to take advantage of their inexpensive costs is all around us. China has quickly moved to fourth place among America’s trading partners. The trading deficit with China was $49 billion in 1997 and stood at close to $84 billion by the end of 2001.¹  

And, foreign direct investment (FDI) stock value has increased from $19 billion in 1990 to $300 billion by 2000. Furthermore, this investment was primarily for greenfield sites as opposed to the U.S. investment of buying and selling established businesses.²

Bringing the China Syndrome issue home to roost, many of distribution’s manufacturing customers have recently moved to China or offshore. Notable brands such as Black and Decker continue to move their operations from the U.S. to Mexico and China searching for ever lower costs.³

Of course, when this happens, the distribution base is affected also. Especially vulnerable are those distributors that have spent their lives courting the manufacturing base including the vertical markets of cutting tools, power transmission, pipe and fittings, and machine tools. However, distributors with a partial portfolio in industrial markets will be affected also and electrical, plumbing, chemical, HVAC, fluid power and finishing markets (among others) are vulnerable to the domestic manufacturing exodus.

Costs and old formulas of value-added apply in China too
When we mention the movement of manufacturing offshore, distributors often remind us that their ability to help manufacturing customers take cost out through new products and supply chain services often offsets any labor savings from foreign countries. While the value-added approaches may have worked in the past, we doubt they will hold back the tide of foreign manufacturing, for several reasons.

First is the sheer advantage of the labor savings. Currently, a fully compensated manufacturing worker in China earns the equivalent of $2,087 per year.⁴ This compares to $3,290 for Mexico and somewhere between $40,000 to $45,000 for the U.S. equivalent.

Traditionally, labor savings are not the leading component of manufactured product costs, with direct materials and direct overhead having significant influence over total cost. However, with a Chinese labor rate only 5 percent of the U.S., you need whopping efficiencies in domestic manufacturing to overcome the difference in labor costs. The value-added savings touted by distributors, while substantial in reducing total costs, generally aren’t substantive enough to keep many industries stateside.

One must also remember that the world is now wired for information. This allows manufacturers the ability to transfer the cost savings knowledge gained from the value-added recommendations of their distributors to overseas plants. Many of the old guard still believe that cost reduction and value-based selling will keep many companies stateside. Most don’t understand that the labor savings and ability to transfer knowledge almost guarantee that this won’t happen. 

Avoid the macro-comparisons
of manufacturing and agriculture
There is a popular misconception that the transition of manufacturing overseas and the drop in manufacturing as a percent of the GDP parallels the agricultural industry during the first half of the 20th century. As the story goes, America was a predominantly agricultural economy until industrialization, when agriculture diminished as a percent of the GDP and was replaced by manufacturing.

In 2003, although agriculture is a small part of the GDP, it has risen in total sales and the U.S. is a net exporter of agricultural goods.⁵ Driving this was the ability of technology to deliver a productivity standard in crop production that overshadowed most cost savings from foreign shores.

Naysayers of the China Syndrome point to the history of agriculture and promise that the same thing will happen in manufacturing. In short, manufacturing may fall as a portion of the GDP, losing out to services, but the cost savings from new technologies and a world-class infrastructure will allow the U.S. to drive domestic productivity to a level that ensures its longevity and rise in overall sales.

While this story is popular and reassuring, it is far too simplistic. First, agricultural production is subject to climate and natural resources, at least more so than most manufacturing. America has long been the envy of other nations as our temperate climate and abundance of water have offered a haven for agricultural production.

Unlike agriculture, however, a manufacturing plant primarily needs a roof, a floor and abundant labor. Hence, manufacturing is ostensibly more transferable than agriculture. Also, because of technology, it is quite possible to break apart the functions of the manufacturing firm to take advantage of the best global cost.

In short, the plant can move to China to lower labor costs, customer service can move to India to lower service and accounting costs, and research, development and marketing can stay in the U.S. to take advantage of the latest knowledge. For these reasons, we view the comparisons of agriculture with manufacturing with a jaundiced eye. The comparatives give reassurance but they deny the inherent differences in products and the effects of technology and globalization.

What’s a distributor to do?
If you have lost manufacturing customers to foreign shores or want to be prepared for this event, we recommend the following preventative measures.

Reviewing your 20/80 customers, have your salespeople look for the following characteristics.

• Look for those that have moved plants overseas outside of your direct market area. If they have moved, and it’s been successful, you can bet that they will use this strategy when it makes sense.

• Review the profits and stock performance of the company. If the company is private, do your best to understand their profit picture. If you walk through the plant, look at the production lines to see if they are full and up-and-running.

• Expand your sales coverage outside of the direct purchasers and users of your products. Talk to company officers or higher-level managers where it makes sense, and ascertain the state of the business.

• Understand the health of the industry(ies) you sell to. For example, if you sell to electric motor manufacturers, research the industry, including its association, to understand if foreign-made goods are taking domestic market share.

• Review the stage of your customers’ products in their industry life cycle. If the products are mature, it is highly likely that foreign competition is in play and the domestic plants are feeling it.

• Finally, understand the cost makeup of your customer’s products. If the products are costly to transport, materials can’t be easily procured from foreign shores, or the manufacturing process needs the best educated workers, then the industry will most likely stay stateside. We call this the Asphalt Plant defense since the cost of aggregates (crushed stone) is primarily transportation-related and most asphalt must have a local heat source before it is applied. It’s a reasonably safe bet to say the asphalt plant won’t move to China.

These steps will definitely help and requiring your sellers to report on these questions for the 20/80 customers is a good defense.

Beyond these steps, review your growth strategy. In our book, Marketing Plans for Growing Sales⁶, we list six growth strategies, only two of which are directly product related. If you haven’t developed a solid marketing process that plans growth and understands where marketing investment needs to be made, then reading up on the subject and initiating a usable marketing strategy will help.

Too often, we find distributors who confuse marketing with selling or sales promotion. Selling is account level strategy. And sales promotion, which we believe is overdone, is running the “buy this, get that” trip or incentive program. A workable marketing process requires a solid understanding of product, price, service, sales and promotion strategies by segment. The plan has to be in place, with responsibilities identified and follow up ensured before the seller hits the street. Anything less than this is the quasi-marketing or sales-driven marketing (smarketing) found in many distribution companies, and it doesn’t work.

If the marketing talk sounds too self-serving, we invite you to consider that the sales philosophy isn’t performing all that well. First, distribution in most vertical markets earns returns that don’t cover their capital cost or are nominal investments. Furthermore, this poor financial performance has been worsening, in many vertical markets, long before the official start of the recession and distributor productivity lags many other sectors of the economy. (See any of the recent association PAR reports or our Progressive Distributor article on “The  Quest for Productivity”).

Second, in the recent Facing the Forces of Change, Outlook 2003⁷, six of the 10 articles presented (by our count), dealt with marketing, channel or marketing strategy vs. sales strategy issues. In short, the push for adoption of the marketing discipline is coming from many areas. With a planned marketing growth strategy, many customers may move to China, but this will have been anticipated and the firm can offset the loss in growth segments.

The U.S. economy is undergoing a shift from manufacturing to service-based. Much manufacturing will stay stateside but much will move offshore. For those who understand the demand drivers of their markets, and adopt a market investment logic, the “fallout” from the China Syndrome is manageable.

1 U.S. International Trade, Congressional Research Service, 2002 Update
2 Foreign Direct Investment in China, Graham and Ward, Oxford Press 2001
3 Notes from Black and Decker form 8 K, July 23, 2002.
4 Adios Mexico, Hola, China, Bloomberg News, Nov. 2002, T.Black.
5 Statement on the State of US Manufacturing, Daniel Griswold, The Cato Institute, June 2001.
6 Marketing Plans for Growing Sales, NAW Publications, nawpubs.org, 1997, 2002, Scott Benfield.
7 Facing the Forces of Change, Outlook 2003, NAW Publications, nawpubs.org, 2002.

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