The true costs of sourcing from China: China isn't spelled 'cheaper,' especially when it comes to raw materials. But lower labor and overhead costs often make the decision worthwhile, though there are still a myriad of issues to understand and consider.

• Author: Carboni, James
• Position: International

Manufacturing in China has become almost a "given" for many U.S.-based manufacturing companies. In reading the press, you might assume that if you are not manufacturing in China, you cannot possibly be competitive--that anything made here can be made much less expensively there. This is not always the case.

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While this article focuses on sourcing of components and sub-assemblies for use in original equipment manufacturer (OEM) manufacturing lines in North America, the issues involved are similar for other China sourcing projects. Armed with knowledge of the differences between Chinese and domestic sourcing, careful management of the issues and a great deal of patience, you can indeed realize great savings by sourcing in China. As a senior financial manager, your analysis of the following cost factors will play a major role in making it happen.

Part or Sub-Assembly Costs

The vendor's quoted purchase cost of the part or sub-assembly is the "hard" number, and the place where the savings occur. And the savings can be great.

Purchase cost is determined by raw material, labor and overhead costs. Expect raw material in China to cost as much as--if not more than--raw material purchased domestically. Savings will be realized through lower labor and overhead costs. Even though labor costs in China are rising, by 2009, labor rates in North America are expected to be roughly 20 times the rates in China, according to Boston Consulting Group's China Report. Companies will also save on overhead, everything from salaries and lease costs to utilities.

The more direct labor involved in the manufacturing process, the greater the savings. When choosing a part or sub-assembly to be manufactured in China, concentrate on labor-intensive, items, then weight these direct cost savings against the additional costs of Asian sourcing.

Freight and Duty

Most quotes from Chinese manufacturers will be FOB (freight on board) Departure Port, such as Hong Kong, Shanghai, etc. You have two choices for freight--sea and air. In almost all cases, sea freight is required. (Two notable exceptions are when your parts cannot be exposed to the environment of a long sea voyage, or when air freight is necessary to prevent a line down in manufacturing.)

The tradeoff is cost versus time. Shipping by air you can get parts in a few days, but the cost will almost always be more than the profit on the part (and possibly more than the sale price). On the other hand...