Implementing a domestic strategy, the company buys nearly all of its material requirements in China (with the exception of (1) some of the capex equipment requirements which are imported from the west and (2) of Aluminium and Zinc which are sourced globally). The total spend sourced locally amounts to approximately $200 million a year. Similarly, the Chinese facilities only serve the local Chinese market as high tariff barriers on steel products make exporting from China uncompetitive

Implementing a domestic strategy, the company buys nearly all of its material requirements in China (with the exception of (1) some of the capex equipment requirements which are imported from the west and (2) of Aluminium and Zinc which are sourced globally). The total spend sourced locally amounts to approximately $200 million a year. Similarly, the Chinese facilities only serve the local Chinese market as high tariff barriers on steel products make exporting from China uncompetitive

The company also has implemented a global procurement network which includes all key procurement heads globally. Taking Asia as an example, this network is now attempting to implement low cost country sourcing opportunities by leveraging the spend at the regional level across the various countries on common categories. Currently, only a limited number of categories are sourced globally (paint, aluminium, zinc), however BlueScope has as a target the objective of increasing this significantly in the coming 2-3 years by leveraging the capabilities of LCC countries such as China and Vietnam.

Mario indicated that he looks at quality, reliability, innovation and price as the 4 key factors driving his supplier selection process. To ensure procurement people’s objectives are fully aligned with the company’s objective, financial and non-financial indicators are used to measure procurement performance. Financial measures are quite standard and focus on the procurement function’s ability to meet budget commitments. Non financial measures include the value of the spend under procurement control and compliance to contracts. Moving forward, the key objectives are to increase the value of the spend under procurement’s responsibility and to increase the amount of categories that are leveraged regionally in Asia as well as globally in order to ensure all categories are sourced from the most attractive locations.

To help achieve this goal, procurement systems (e.g.: ERP system) will be implemented in the coming 2 years and rolled out throughout the whole of Asia in order (1) create better transparency in the spend across countries and BU’s, and (2) to reduce the administrative workload of the procurement people allowing them thereby to spend a much larger percentage of their time on higher value added strategic sourcing activities

Regarding the inherent quality of the Chinese suppliers, Mario’s perspective is that they are very fast learners and are for many of them operating at similar (and sometimes higher) levels of performance compared to their global competitors. Mario segments the Chinese suppliers into three categories: (1) backyard suppliers, i.e.: suppliers whose immediate future is uncertain; (2) middle tier supplier, i.e.: suppliers who are likely to remain in business but without the capability of supplying the high end of the market they operate in, and (3) top tier suppliers that operate at the premium end of the business capable of competing with anybody in the world.

Finally, in terms of characteristics of Chinese suppliers versus Western suppliers, the only salient difference pointed out by Mario is the much stronger emphasis put by Chinese companies on relationships compared to the more contractual type relationships that exist in the West. Mario’s view is that the strength of these relationships are particularly useful in difficult times making it easier for the 2 parties to sit around the table in order to find a win-win solution rather than revert to a more legalistic approach which is more pervasive in the West

The magnitude of China’s economic growth in recent years has been truly astonishing. Its GDP has expanded at an average of 9.6 per cent each year for over 25 years. Overall trade volume has exploded to more than USD1.76 trillion. The trade surplus, a staggering USD177.47bn, has ballooned to untenable levels. The waves are being felt on a global basis, forcing the government to rethink and reshape the strategies responsible for fueling this growth while focusing on long-term sustainable growth.

A cornerstone of China’s success has been the growth in export manufacturing through a programme called Processing Trade. This programme has saved companies billions of dollars in duty and VAT costs. Without it, prices for Chinese export goods would be less competitive. But recent regulatory changes to Processing Trade are increasing costs, adding operational complexity and causing companies to reconsider China’s status as a preferred global manufacturing base.

The Processing Trade programme permits a company to import raw materials free of duty/VAT for producing export goods. It is used by a majority of export manufacturers to legitimately manage indirect tax costs.

In just over 25 years the value of Processing Trade has increased 333 times from USD2.5bn in 1981 to USD831.9bn in 2006 and accounted for over 50 per cent of the total import/export value. In the first half of 2007, the Processing Trade total import and export value rose 17.6 per cent to USD440.9bn.

Two types of manufacturing structures are employed under the Processing Trade in China: Contract Manufacturing (进料加工)and Toll Manufacturing (来料加工). Most factories manufacture under Processing Trade using one of these structures.

There has been a flurry of new Processing Trade regulations promulgated over the last couple of years. As China endeavours to address trade, economic, social and political challenges, it is increasingly utilizing trade programs, such as Processing Trade and export VAT refunds, as “tools” to guide certain macro-economic policies and adjust long-standing investment patterns. The Vice Minister of MOFCOM, Wei Jianguo, said, “We are striving to improve the development of China’s Processing Trade programme in a bid to promote trade balance and reduce the trade surplus”.

Not all companies and types of production can enjoy the benefits of Processing Trade and certain restrictions apply

There has always been a list of designated products which China does not allow to be produced under Processing Trade. The most recent list places prohibited products into the following categories: exported finished goods; imported raw materials; and combinations of finished goods made with certain imported raw materials. Prohibited products can be manufactured for export but the raw materials cannot be imported on a bonded basis. The following recent policy adjustments, among others, have significantly expanded the product coverage of the Prohibition List over the last year:

• Decree No. 139 and 145 (September 2006) stated that products with a 0 per cent export VAT refund rate would be placed on the Prohibition List;
• Announcement No. 82 (November 2006) and Announcement No. 17 (April 2007) updated and added items to the List as well as consolidated different Prohibition Lists;
• Supplement to Announcement No. 17 (July 2007) included additional items and clarified others that are not on the list;

A new “restricted” category was added to the changing landscape of Processing Trade. On 23 July Announcement No. 44 created a list of restricted products that covers over 1,800 tariff codes and places monetary and geographic restrictions on export manufacturers. The new restrictions can have a serious impact on a company’s supply chain, cash flow and operating location. The following restrictions are imposed on affected products:

• Companies must post cash deposits for the estimated amount of their duty/VAT liability. Companies with an A or B grading are allowed to post only 50 per cent of the amount, while C grade companies will have to post 100 per cent. If an A or B grade company is already located in middle and western China, then the deposit requirement may be waived.
• If a factory to manufacture restricted products was not approved to conduct Processing Trade before 23 July, then the company will not be allowed to conduct this activity in the coastal provinces. A company currently manufacturing under Processing Trade without import/export rights must obtain the rights before 23 October to be able to continue producing such products.
• The restricted list applies to E-handbooks but does not apply to special zones (e.g., export port processing zone, bonded zone, etc.) and special types of bonded factory transfers.

It is tricky to try and predict the next Processing Trade changes to be introduced by the Authorities. But we do expect there to be more changes.

The Prohibition List is likely to be in a continual state of revision. This List is now published online and this gives the authorities greater flexibility to add and delete items. The Restricted List will be monitored and likely adjusted from time to time. They may even initiate certain adjustments where the results differed from the expected outcome.

Currently, HS codes are being used to select the affected products. This is not a perfect method, and it may be plausible for additional criteria, other than just the HS codes, to be contemplated in future changes.

An even more radical position may be to ask whether Processing Trade, in its current form, has outlived its usefulness. If so, then fundamental changes or a scrapping of the entire programme may be necessary. The authorities are contemplating alternatives, but such structural change will not come easily.

Processing Trade provides a huge cost savings to export manufacturers. To enjoy the benefits companies must understand the regulations and employ operational procedures to ensure compliance. Failure to do so will result in additional duty/VAT liabilities payable. Given the large volumes and quantities of goods manufactured for export, the resulting costs can be material and usually come as an unwelcome surprise. A few of the most common issues are listed below:

• Inability to reconcile bonded inventory – It can be difficult to appropriately track the usage of the bonded raw materials and often there is a large variance between the quantity Customs has in their records and the actual physical quantity in the warehouse.
• Domestic sales – Some manufacturers will sell goods to both the domestic and export markets. Bonded raw materials may be included in goods sold domestically. Domestic sales including bonded raw materials must be reported on time to Customs and duty/VAT paid thereon.
• Closure of a handbook – Many times it is too difficult for the operational staff to reconcile the handbook at the time of closure. Thus, the irreconcilable ending balances are “rolled forward” to the beginning balances of a new handbook. The irreconcilable balances then compound over a period of time and increase the risk exposure to the company.

Processing Trade has and will continue to play an important role in the development of China’s economy. The authorities are beginning to experiment with the programme as a “tool” to engineer and force changes necessary for China’s long-term growth. By prohibiting, restricting or encouraging production in certain industries or of specific products, they hope to nudge the economy towards higher value-added manufacturing.

The new regulatory changes can significantly impact company operations and future investment decisions. The authorities recognize that these changes negatively affect a number of businesses and are monitoring the impact. But they seem willing to accept a certain level of downside to address the larger issues such as the trade surplus, environmental pollution, limited energy and natural resources, balance of wealth in China and social order.

It will be interesting to watch as the effects from these changes are manifested in the economy. Companies will be casting a wary eye on implementation. The authorities are also eager to see if this experiment in tinkering with Processing Trade will pay off as expected. Either way, we will have to wait for a while to see how this all plays out.