ENVIRONMENT
5. Experimental Design 1. Experimental scenarios1.Experimental scenarios
The objective function (1) minimizes yearly LC in all international mar- kets. LC components include selling prices of the manufacturer, freight costs and tariff costs. Equations (2)–(6) are convenience constraints to simplify model formulations while defining individual cost components, including manufacturing cost, domestic freight cost, international freight cost, corpo- rate income tax and VAT tax. Equation (7) is a constraint on net profit margin after tax. Equation (8) is a demand constraint. Constraint (9) ensures that no facility is open without any production. Constraint (10) is a binary force constraint. Constraints (11)–(13) define the characteristics of variables.
5. Experimental Design
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Table 3 Manufacturing cost data.
CRCf RLCf DLCf Hrf IDMf IDTfm RMCf
PRD 6.85 0 12.77 0.8 35 28 $2.35
Guangdong 5.01 1.17 10.23 0.8 36 28 $2.35
Pan-PRD 4.81 1.33 9.81 0.8 37 28 $2.35
Inland 4.38 1.67 7.36 0.8 42 28 $2.35
India $0.87 $0.50 $0.85 0.9 42 35 $2.35
Mexico $1.19 $0.58 $2.17 1.0 35 7 $2.35
Table 4 Prevailing tax, tariff rates and freight costs.
Ctaxf VATf Tarifffm DFCf IFCfm
PRD 15.0% 4% 20.0% 0.288 $0.593
Guangdong 4.0% 4% 20.0% 0.552 $0.593
Pan-PRD 4.0% 4% 20.0% 1.000 $0.593
Inland 4.0% 4% 20.0% 4.000 $0.593
India 4.0% 0% 20.0% $0.049 $0.752
Mexico 5.8% 0% 0% $0 $0.208
shoes. Its business model and material flow represent most PTEs in the region.
Tables 3 and 4 present various input data in relation to the US market.
The first rows give parameters corresponding to definitions in Sec. 4. Labor costs at all locations are valid as in 2008. All transportation modes use 40FT full containers or equivalent, which contains 4,800 units of finished products.
Data for costs in India and Mexico are given in the USD. Major data sources are Hong Kong Trade Development Council (HKTDC), Investment Com- mission of India, ProMexico, Werner International, Shenzhen Container Trailer Association and four logistics service providers.
Demand of the US market for the manufacturer is 6,000,000 units per year. Correlation factor between freight costs and oil price (φ) is 40.4% in relation to the base oil price (Rubin and Tal, 2008). Inventory holding cost coefficient (µ) is set as 25% per year to account for the cost of holding inventory in transit or at manufacturing sites.
6. Results, Analysis and Findings 6.1. Modeling results at base scenario
As the numerical example considers only the US market, only a single manufacturing facility is suggested to be in operation at all scenarios. Values
Table 5 Landed cost comparison at base scenario.
Manufacturing location Landed cost per unit Difference to PRD
PRD $7.06 —
Guangdong $6.54 −7.46%
Pan-PRD $6.53 −7.52%
Inland $6.58 −6.90%
India $6.68 −5.50%
Mexico $6.94 −1.70%
of decision variableqfmat all scenarios equal to the market demand. Table 5 shows modeling results of LC per unit of product at candidate locations at base scenario. It suggests highest LC savings of 7.52% can be achieved by relocation to Pan-PRD, followed by 7.46% for Guangdong and 6.90% for Inland. Inland has the lowest labor cost in China, but its freight cost is much higher than that of PRD and Guangdong. Relocation to India brings LC savings by 5.50%, which is less competitive than the three candidate locations in China. The advantage of lower labor cost in India is offset by its higher logistics cost. It is surprising that relocation to Mexico brings LC reduction of 1.70% though its labor cost is much higher than that of PRD.
This is mainly due to its much lower logistics cost to the US and zero tariff benefit under NAFTA.
6.2. Sensitivity analysis
Figure 3 consists of four graphs to show the results of sensitivity analysis.
Graphs 3(a) and (b) employee comparative values of factors in relation to base scenario, while graphs 3(c) and (d) use absolute values of factors.
The comparison of graphs (a), (b), (c) and (d) suggests that impacts of RMB exchange rates and labor costs in the PRD region are most significant. For the current manufacturing operation in the PRD region, 10% RMB appreciation against base scenario would raise LC from $7.06 to
$7.40. Labor cost increase by 20% would push up LC from $7.06 to $7.46.
In comparison, impacts of oil prices and VAT rebates in China are less significant.
Impacts of factors on optimum relocation destinations could be dra- matic. Graph 3(a) suggests that RMB appreciation of 10% against base scenario would cause all three locations in China to lose advantage to India.
The cost advantage of manufacturing in China has become very slim after RMB appreciation of over 20% since 2005. Further RMB appreciation would quickly erode its cost competitiveness over lower cost countries in Asia.
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$6.0
$6.5
$7.0
$7.5
$8.0
90% 100% 110% 120% 80% 100% 120% 140% $37.5 $75 $150 $225 $300 8% 11% 13% 15% 17%
(c) Oil price
(a) RMB Exch (b) DLC in PRD (d) VAT rebate in China
Landed cost in U.S.
PRD Guangdong Pan-PRD Inland India Mexico
Fig. 3 Results of sensitivity analysis.
Graph 3(b) suggests that the labor cost in the PRD region has become too high for the PTE to stay competitive. Even if its labor cost decreases to 80%
of the level as in base scenario, it would still not become most competitive.
Continual rise of labor cost in the PRD region would further undermine its competitive position. Graph 3(c) shows that high oil prices adversely affect manufacturing locations with higher logistics costs, for example, Inland of China and India. Such effects from oil prices could dramatically alter optimum relocation destinations. If oil price stays at low level of $37.5 per barrel, Inland of China would be the optimum relocation destination due to its lowest labor cost. At base oil price of $75 per barrel, Pan-PRD is most cost competitive. At oil prices of $150 and $225 per barrel, Guangdong is most cost effective due to its lower freight costs than Pan-PRD. If oil price rises wildly to the very high level of $300 per barrel, Mexico would be the best location to serve the US market. High oil prices amplify the logistics advantage of production in Mexico. Graph 3(d) suggests that changes of VAT rebates in China between 11% and 17% do not cause the shift of optimum relocation destination. However, if VAT rebate decrease to be as low as 8%, India will become most cost competitive.
In general, manufacturing in Pan-PRD and Guangdong leads to minimal difference on LC at all scenarios. In comparison with base scenario of manufacturing in the PRD region, relocation to either of these two locations will bring about 20% labor cost savings and only incur slightly
higher freight costs. Besides lowest LC, they will bring least challenges on supply chain lead time, language, culture difference, or availability of skilled labors. It is likely that Pan-PRD and Guangdong will attract a large number of relocating PTEs if business environment does not deviate far from base scenario.
6.3. Scenario analysis and findings
Table 6 summarizes impacts of factors on the choice of primary relocation destinations in relation to base scenario. Future scenarios only consider changes in a single factor. In most scenarios, Guangdong and Pan-PRD are the most preferred relocation destinations. Exceptions only happen in four scenarios: if RMB currency appreciates more than 10% against base scenario, Asian lower cost countries become more preferred; If oil price stays at very low level of $37.5 per barrel or below, Inland of China become most cost competitive; If oil price persists at very high level of $300 per barrel or above, Mexico would become most favorable. If VAT rebate in China
Table 6 Scenario analysis on factors and relocation trends.
Primary relocation
Factor Future scenario destinations
RMB to USD exchange rate
Depreciate Guangdong and
Pan-PRD
Stable Guangdong and
Pan-PRD Appreciate by less than
10%
Guangdong and Pan-PRD Appreciate by more than
10%
Asian lower cost countries Labor cost in the PRD
region (2008 constant price)
Drop slightly Guangdong and
Pan-PRD
Stable Guangdong and
Pan-PRD
Rise Guangdong and
Pan-PRD Oil price per barrel (2008
constant price)
$37.5 Inland
$75; $150; $225 Guangdong and Pan-PRD
$300 Near major markets
VAT rebate in China Between 11% and 17% Guangdong and Pan-PRD
8% or below Asian lower cost countries
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falls to 8% or below, Asian lower cost countries will gain advantage over locations in China.
It should be noted that the combined effect of multiple factors may cause the relocation dynamics more complicated. For example, both RMB currency appreciation and VAT rebate decrease cause locations in China less competitive than lower cost countries in Asia. The combined effect of these two factors would cause changes in critical levels of factors which trigger the shift of optimum locations. Taking VAT rebate as an example, its changes between 11% and 17% do not alter optimum manufacturing location if other factors stay as in base scenario. However, if RMB appreciates another 5%
against base scenario, changes in VAT rebates in the same range would cause the shift of optimum manufacturing locations. Another example can be seen on the change of critical oil price causing manufacturing moving near major markets. If RMB appreciates another 10% against base scenario, oil price $170 per barrel would cause Mexico more competitive than lower cost countries in Asia.
Following the above analysis on relocation trends, Table 7 suggests their implications on HKP development. Relocation of PTEs to other parts of Guangdong province may bring mixed effect. If PTEs move to western Guangdong, their cargoes are more likely to be captured by HKP. If PTEs relocate to northern or eastern Guangdong, HKP will be less favored in comparison with Guangzhou and Shenzhen ports respectively. If PTEs move to Pan-PRD, HKP development will be in greater danger as land transportation will become the dominant mode of cargo transportation.
Besides its disadvantage on cargo transported via trucking, HKP is lack of railroad linkage. It will lose opportunities to Shenzhen and Guangzhou ports when railroad becomes most economical for long distance land transportation. Such an unfavorable position will be seen for HKP if PTEs
Table 7 Implications of relocation trends on HKP development.
Implications on HKP Relocation destination Nearest mainline ports development
Guangdong West Hong Kong Slightly favorable
North Guangzhou Slightly unfavorable
East Shenzhen Slightly unfavorable
Pan-PRD Shenzhen, Guangzhou Modestly unfavorable
Other Inland areas of China Shanghai, Ningbo-Zhoushan, Qingdao, Tianjin
Most unfavorable Lower cost countries in Asia Ports in or near the location Most unfavorable Near major markets Ports in or near the location Most unfavorable
shift their operations to provinces which are far away from Hong Kong, including west part of Pan-PRD and other inland provinces. If PTEs move to lower cost countries in Asia, HKP will lose geographical proximity to cargo source. At most, it will intercept some transshipment cargo from nearby lower cost countries in Asia. Relocation to near major markets would happen when oil price stays at very high levels, which will greatly discourage global trade. HKP development, along with other ports in Asia, would become very pessimistic in this scenario.