Can high-mix, low-volume production succeed in China? You bet.

In the 1970s, if you set up a contract manufacturing shop in a good location, customers eventually would walk through the doors. In the real world, things quickly changed for American companies, as OEMs, driven by maximizing shareholder value, searched for cheaper sources offshore. The first options were Hong Kong, Malaysia and Singapore. After prices increased in these countries, greener pastures were found in China. Unfortunately, as the saying goes, all good things must end.

Believe it or not, “Made in China” does not mean cheap anymore. Outsourcing to China was a trend that became popular starting in the mid 1990s. At that time, demand for China sources far outweighed the supply, driving up prices. Along the way, China accrued sizable foreign exchange reserves filled with US greenbacks, with the trade deficit between the US and China hitting $226 billion by 2009.

With mounting pressure from the US government and the World Trade Organization, China has begun to loosen trade restrictions. It has decided to shift toward manufacturing higher value goods, so the trade deficit “quotas” are not wasted on lower-margin products like Tupperware and toys. China has taken a three-step approach to doing this: First, it has selectively increased import duties on materials used in the manufacturing of low-value products. Second, it has dramatically improved the employment conditions of factory workers by demanding significant increases in paid benefits and minimum wages. Third, it is slowly phasing out free trade zones and licenses.

The free trade license, known as san li yi bao, permits companies, many from Hong Kong, to set up production facilities in China without paying any import duties or value-added taxes. The caveat is that all products manufactured must be exported. This was introduced by Prime Minister Deng Xiao Ping in the late ’80s as a means of attracting investments so that the post-Mao Chinese could work in meaningful jobs, as opposed to laboring away on farms. This program certainly succeeded in meeting its goals. China, with a population of 1.3 billion people, is now facing a massive labor shortage. As of February, the China Times reported, the Pearl River Delta area faced a shortage of two million workers.

My company, Season Group, is a global EMS provider with a mega-site in Dongguan, among others. Like others in China, we are facing these issues. How do we cope? By being open to change. As Charles Darwin wrote, “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.”

Growing up, I was often discouraged to enter contract manufacturing, as it operates in what some term a “herd-like mentality.” This means contract manufacturing always goes wherever labor is the cheapest, just as herds do when grazing. Unlike the pastures, though, cheap labor does not return to a country once a higher wage has been set. This means cheap labor becomes scarcer, and all businesses must be prepared for it.

When Western OEMs formulate their outsourcing strategy, they must maintain a strict protocol: Low-mix, high-volume (LMHV) work is outsourced to Asia, while all high-mix, low-volume (HMLV) work stays onshore. HMLV is by nature more complex, as the same amount of preparation work needs to be done at a higher frequency when comparing HMLV to LMHV. The characteristics of HMLV work make strong communication between OEM and EMS partners a must, which gets difficult when different languages, cultures and time zones come into play.

Here’s where Darwin comes in. Foxconn, the world’s largest EMS provider, has announced a fully automated production facility in Taiwan as a test run. If successful, it will emulate this plant throughout China so that it is not bound by labor shortages. Season will continue to invest internationally as a means of diversifying our risks. Our Penang, Malaysia, facility will be expanded to replicate our China site, with vertically integrated manufacturing capability, including wire harness assembly, PCB assembly, mold and die making, plastic injection molding and plastic thermoforming. This facility provides us with stabilized costs, as wages in Malaysia have not changed much in the past 10 years.

Not all products are suitable for offshore production: low-volume, bulky, IP-sensitive, national security, etc. In the near future, there will be a surge of de-sourcing activities in Asia that will result with the production sent back to the US.

If you think your current manufacturing strategy is optimal and can last an eternity, be ready for a rude awakening. With economic dynamics changing on a daily basis, no strategy is permanent. Many in the textile industries rushed to Bangladesh in 2009 due to favorable economic circumstances compared to Vietnam; thus, land prices – and subsequently, labor prices – were driven up. Now, with the Vietnamese currency down to 18,885 dong per $1 (from highs of 16,000 per $1), it makes sense to look at Vietnam again. When outsourced assembly work started leaving the US shores for China in the mid 1990s, few thought it would ever come back. The current trend of onshoring proves no strategy is ever safe.

Carl Hung is vice president - Season Group (seasongroup.com); carl.hung@seasongroup.com.