Wednesday, June 20, 2007

Fallows on Shenzhen

Speaking of Shenzhen, here is the recent Fallows article in the Atlantic (subscription required): China makes, the world takes. Narrated slideshow (free) here.

I first visited Shenzhen on a day trip from Hong Kong in the early 90's. I was excited to see it, since it was one of the first Special Economic Zones (SEZ) set up by the communist government. My friends in HK couldn't understand why I would want to visit -- they suggested scenic Guilin instead. But I was already fascinated by the rapid economic changes taking place; I wanted to see China's future, not its past. At the time, everything was rough: roads were terrible, new buildings had no sidewalks or landscaping, our bus was caught in some of the worst traffic jams I have ever seen. Now you can take the subway/train there directly from HK, there are 8 million residents, and (I'm told) the city is full of parks and green spaces.

From the article (excerpts found here):

...Has the move to China been good for American companies? The answer would seemingly have to be yes—otherwise, why would they go there? 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.

Fallows' guide is an Irish entrepreneur who couldn't get a US green card (found here):

...Mr Fallows centers his story on an accidental entrepreneur, Irishman Liam Casey. Mr Casey lives in Shenzhen because that's where the action is. But he'd be living in Laguna or Newport Beach if he could. He loved it there. But he couldn't get a green card or a long-term work permit, so he moved on. Mr Fallows notes parenthetically,

I might as well say this in every article I write from overseas: the easier America makes it for talented foreigners to work and study there, the richer, more powerful, and more respected America will be. America's ability to absorb the world's talent is the crucial advantage no other culture can match - as long as America doesn't forfeit this advantage with visa rules written mainly out of fear.

The supply chain in action (here):

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.”

Or: 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.

For the world’s most efficient supply chain:

Or: You are a very famous American company, and you worry that you’ve tied up too much capital keeping inventory for retail stores at several supply depots in America. With Mr. China’s help, you start emphasizing direct retail sales on your Web site—and do all the shipping and fulfillment from one supply depot, run by young Chinese women in Shenzhen, who can ship directly to specific retail stores.

Over the course of repeated visits to Shenzhen—the breakfasts!—and visits to other manufacturing regions, I heard about many similar cases and saw some of the tools that have made it possible for Western countries to view China as their manufacturing heartland.

Some involve computerized knowledge. 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.)

The idea that your supply chain is critical intellectual property is obvious. That is why we know so little of the origins of our shiny new MacBook Pro or HP widescreen display. It also highlights why how a company differentiates through innovation and design [e.g., Apple] because it’s products are likely made on the same assembly line as competitors.

I could describe many installations, but I was fascinated by two. The first represents one extreme in automation. It is owned and operated by Inventec, one of five companies based in Taiwan that together produce the vast majority of laptop and notebook computers sold under any brand anywhere in the world. Everyone in America has heard of Dell, Sony, Compaq, HP, Lenovo-IBM ThinkPad, Apple, NEC, Gateway, Toshiba. Almost no one has heard of Quanta, Compal, Inventec, Wistron, Asustek. Yet nearly 90 percent of laptops and notebooks sold under the famous brand names are actually made by one of these five companies in their factories in mainland China. I have seen a factory with three “competing” brand names coming off the same line.

The Inventec installation I saw was in an export-processing zone in Shanghai specially created for the company, in which imported components for manufacturing and finished products for export were free of the usual duties or taxes. It turns out more than 30,000 notebook computers per day, under one of the brand names listed above. Each day, an Inventec plant on the same campus produces hundreds of large, famous-brand-name server computers to run Internet traffic.

This is today’s rough counterpart to the Ford Motor Company’s old River Rouge works. In the heyday of The Rouge, rubber, steel, and other raw materials would come into the plant, and finished autos would come out. Here, naked green circuit boards, capacitors, chip sets, and other components come in each day, and notebook computers come out. Some advanced components arrive already assembled: disk drives from Taiwan or Singapore, LCD screens from Korea or Japan, keyboards and power supplies from other plants in China.

The overall process looks the way you would expect a high-tech assembly line to. Conveyers and robots take the evolving computer from station to station; each unit arrives in front of a worker a split second after she has finished with the previous one. Before a component goes into a machine, its bar code is scanned to be sure it is the right part; after it is added, the machine is “check-weighed” to see that its new weight is correct. Hundreds of tiny transistors, chips, and other electronic parts are attached to each circuit board by “pick and place” robots, whose multiple arms move almost too fast to follow. The welds on the board are scanned with lasers for defects. Any with problems are set aside for women specialists, looking through huge magnifying glasses, to reweld. Why did this factory invest so much in robots and machine tools? I asked a supervisor from Taiwan. “People can’t do it precisely enough,” was his answer. These factories automate not what’s too expensive but what’s too delicate for human beings to perform.
Did you know that new USB headset you just bought was packed and shipped from China?

The other facility that intrigued me, one of Liam Casey’s in Shenzhen, handled online orders for a different well-known American company. I was there around dawn, which was crunch time. Because of the 12-hour time difference from the U.S. East Coast, orders Americans place in the late afternoon arrive in China in the dead of night. As I watched, a customer in Palatine, Illinois, perhaps shopping from his office, clicked on the American company’s Web site to order two $25 accessories. A few seconds later, the order appeared on the screen 7,800 miles away in Shenzhen. It automatically generated a packing and address slip and several bar-code labels. One young woman put the address label on a brown cardboard shipping box and the packing slip inside. The box moved down a conveyer belt to another woman working a “pick to light” system: She stood in front of a kind of cupboard with a separate open-fronted bin for each item customers might order from the Web site; a light turned on over each bin holding a part specified in the latest order. She picked the item out of that bin, ran it past a scanner that checked its number (and signaled the light to go off), and put it in the box. More check- weighing and rescanning followed, and when the box was sealed, young men added it to a shipping pallet.

By the time the night shift was ready to leave—8 a.m. China time, 7 p.m. in Palatine, 8 p.m. on the U.S. East Coast—the volume of orders from America was tapering off. More important, the FedEx pickup time was drawing near. At 9 a.m. couriers would arrive and rush the pallets to the Hong Kong airport. The FedEx flight to Anchorage would leave by 6 p.m., and when it got there, the goods on this company’s pallets would be combined with other Chinese exports and re-sorted for destinations in America. Forty-eight hours after the man in Palatine clicked “Buy it now!” on his computer, the item showed up at his door. Its return address was a company warehouse in the United States; a small Made in China label was on the bottom of the box.


Anonymous said...


Thank you so much for sharing your experience and this wonderful (and most enjoyable) article. I will have to buy this issue of the Atlantic!

The slideshow just blew me away; nothing like this happening in India (a lot of good is, of course). And they have got this flourishing SEZs AND also tackled hunger better than India. Amazing achievement!

BTW, how much is a "$1000 laptop" there? As you keep pointing out, it is PPP that is more relevant for comparing standard of living...

I recently talked to one businessman who goes on business trips to China. He said he is embarassed to use his cell phone there; the ones there are much more sophisticated. I had heard about Japan and HK being way ahead (higher speed internet, cell phones as credit cards, watch TV, etc), but was surprised that it was like that in (at least parts of) China as well...

I am also surprised to see the "green" aspect of growth of Shenzhen. It is no Eugene, but still...


PS: I enjoy your taste on globalization articles a lot.

Steve Hsu said...


Thanks very much for your comments. If you ever come across any interesting India articles send them to me and I will post them here. Apparently Charlie Rose has been doing some very interesting interviews with business leaders there this week.

I suspect a laptop costs almost the same there as here. A few of the costs like shipping, Windows Vista license, value of western brand might go away, but most will stay.

It's things like food, rent, clothes, cellphone charges, etc. that are much cheaper in China. One thing that did surprise me was that Duracell batteries were significantly (factor of 2 or more?) cheaper in Beijing than here. Maybe they were fakes, maybe it costs a lot to ship them due to their weight, who knows.

One of the most interesting things I've found on the globalization subject was that blog written by an Indian software developer living in Shanghai. There must be more stuff out there like it.

Bunnie Huang and I are going to do a round table at foo camp on business and technology in China. Some real Chinese entrepreneurs and technologists will be there as well. I hope to learn lots of interesting stuff, which I'll do my best to report...

Anonymous said...


I wish I could point out good sources on India, but you already doing a vey good job (and do much, much more!). For some strange reason, economic journalism in India is quite disappointing --- they don't seem to present their own (and fresh) prespective on things, rather than just rewrite stuff already noted in western magazines.

Here is a recent special issue in an Indian business magazine on SEZs in India that shows the challenges of duplicating the China model in India; unfortunately, not much good stuff there...

It's things like food, rent, clothes, cellphone charges, etc. that are much cheaper in China.

Only cellphone charges are cheaper in India than here. Food and (not necessarily 'good') housing in major cities is more expensive there than here. In fact, it uses up a bulk of the income of most of the middle class professionals; only s/w professionals can afford to save a decent amount. The situation in China seems MARKEDLY better (sure, we are comparing middle classes in the 2 countries).

Yes, I remember the blog post from an Indian s/w in China, which was quite interesting/illuminating to me as well.

Anyways, please keep writing on this most fascinating topic. I eagerly await your summary of the foo camp round table on business and technology in China (and foo camp in general, of course)---very exciting topic indeed!


Anonymous said...

Ahhh, cheap labor . . . Nothing's impossible without them. Chairman Mao would agree with the "Long March" toward industrialization. That being said, China has a pork problem. Pork prices have skyrocketed and the masses are getting restless. Being organic beings, increasing economic conditions demand better diet from the masses. How long before inflations/social instablility catches up before manufacturing becomes infeasible in China?

Suzy Lounge said...


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