Making money in China but keeping it mum (#83; Topic B)

More and more USA companies are setting up shop in China, making tons of money, but keeping it mum. In the meantime, USA's trade deficit grew (to a record $725.8 billion for 2005), and demands for China to revaluate her yuan became even more vocal. A couple of days ago, I read, in the Wall Street Journal, a passing reference to the effect that the Chinese manufacturer producing a bra selling for $25 at Wal-Mart makes but 50 cents. Using this and other tidbits, let's reconstruct the process. Usually, the retail price is 3 times the FOB cost, giving the invoice price of a bra in China at $8. Material generally accounts for 60% of production cost, giving $5. About 60% of material is imported, meaning $3 (in $ terms) are unaffected by currency revaluation. After production, financing, shipping, forwarding, and other services to move the bra to US take place -- mainly done by US-controlled companies, beyond the ability of small manufacturers in China. So, out of all these, only $5 are controlled by the manufacturer in China (= $8 - $3), from which he pays for domestic material, labor, overhead, and profit. Assuming labor cost is 20% of this, which amounts to $1, or 8.08 yuan based on the current exchange rate. Assume the exchange rate is revalued by, say, 20 percent (an unlikely large move), so that 8.08 yuan (= $1) in labor cost now becomes $1.20 (= 8.08 divided by 6.8). The Chinese manufacturer may elect to absorb it, thereby reducing his profit from 50 cents to 30 cents. Even if he passes the whole 20 cents onto Wal-Mart, his invoice price is but $8.20. Wal-Mart, in turn, may absorb the whole increase or, more likely, ask all these service institutions to share the 20 cent increase by suitable price reduction. Even if Wal-Mart elects to pass the entire increase to customers (and triple it in the process), the ticket price is but $25.60. In other words, even a 20% currency revaluation affects the invoice cost by only 2.5% and retail price (before tripling) by but 0.8%. Conversely, companies like GM, which generated $238 million in profit last year from its operation in China (WSJ, 2/13/06), would be adversely affected.
Posted at 4:28 pm, Monday, February 13, 2008