Is it really worth it? From tainted pet food, seafood, and toothpaste to unraveling tires, exploding cell-phone batteries, and lead-painted children's toys, defective products from China are giving U.S. companies second thoughts about the benefits of China's low-cost manufacturing.

In August, Mattel announced that its Fisher-Price division was recalling nearly 1 million toys — 83 products — that were finished with lead paint. All were made in China. Prior to that announcement, 24 types of toys had been recalled in the United States in 2007, and all were manufactured in China. In June alone, 68,000 folding chairs, 2,300 toy barbecue grills, 1.2 million space heaters, 5,300 earrings, 19,000 children's necklaces, and 1.5 million Thomas the Tank Engine toys were recalled. All of them were stamped "Made in China." A staggering 60 percent of all product recalls have been traced back to the country, according to the U.S. Consumer Product Safety Commission (CPSC).

Yet by and large, companies and the consultancies they hire to evaluate sourcing opportunities in China continue to say that the risk of recalls is worth taking. "If you manage and maintain quality in your sourcing operation and invest in it, the benefits are too large to ignore," says Bill Ferko, vice president and CFO of Genlyte Group (2006 revenues: $1.5 billion), a Louisville-based manufacturer of lighting fixtures that sources components, subassemblies, and finished products from more than 20 factories in China.

Learning from the experience of U.S. apparel makers, which achieved huge cost savings by manufacturing in China in the 1980s only to incur public wrath when inhumane working conditions in the country were revealed, many manufacturers like Genlyte have developed strict quality protocols in their China sourcing. The process begins with systematic evaluations of potential suppliers, which are provided written expectations of product quality and safety specifications. Quality-assurance inspections by in-house or retained engineers follow, ending with a final check of the product at the importer's loading dock. In between is a legion of other tactics to combat potential problems such as intellectual-property theft and poor labor conditions.

But quality programs are not infallible. Mattel, for example, not only had quality controls but had also worked for 15 years with the Chinese plant that made the lead-painted toys. "They understand our regulations, they understand our program, and something went wrong," CEO Robert A. Eckert told The New York Times in August.

Systemic Problems
There is no mystery why U.S. businesses flock to China: the country's giant workforce churns out nearly a trillion dollars in goods and services at a labor cost that would be illegal here. Typically, a U.S. or Western European factory worker costs an employer $15 to $30 an hour; a Chinese factory worker, by contrast, earns less than $1 an hour, according to Boston Consulting Group (BCG).

Even if wages in China were to increase at a 15 percent annual rate over the next five years and rates in the United States were to increase at a 3 to 4 percent clip, average hourly wages would be a scant $2 in China and $18 to $36 in the United States. While currency exchange rates play a role in this calculation, BCG says even a fourfold strengthening of the yuan against the dollar would still make wages in China half what they are here. Small wonder that China currently provides 40 percent of U.S. consumer imports, nearly $250 billion worth of goods annually.

"China is generally competing on price, not on quality or safety or the integrity of the supply chain," says Pietra Rivoli, a professor at the McDonough School of Business at Georgetown University and author of the book The Travels of a T-Shirt in a Global Economy. Expecting the government of China to solve manufacturing quality issues for importers is quixotic, she says. "There are few, if any, safety nets."

For example, China has no equivalent to the CPSC. While the government has promised stricter enforcement of regulations, stepped-up inspections, and more-punitive actions against makers of substandard goods, it also has intimated that the recent debacle surrounding product quality was exaggerated by the foreign media. "The country's usual response to a scandal is to find a scapegoat," Rivoli says, pointing to the recent execution of the head of China's food and drug administration, Zheng Xiaoyu, convicted of accepting bribes linked to substandard drugs.

"Officials don't want to admit the fallibility of the system, because that hurts their power," adds Rivoli. "They'd rather find fallibility in an individual." Nevertheless, she says, the recent recalls "are not isolated problems of product quality. They're systemic."

A recent nationwide survey of food, drugs, and consumer products by China's General Administration of Quality Supervision, Inspection, and Quarantine backs her up, finding that 20 percent were substandard or tainted. For example, more than 23,000 cases of low-quality or fake food were uncovered, requiring the closure of 180 food factories. The results were often shocking: bread with 50 percent paper-pulp content, pigs fattened on force-fed wastewater, lard made from sewage.

The disgusting revelations have taken the gleam off China's low-cost labor for some. "Companies must move away from an all-China, all-the-time sourcing policy," insists Paula Rosenblum, managing partner of Retail Systems Research. "Continual and increasing dependence on China as the sole source for manufacturing is a mistake waiting to happen."

Do They Really Get It?
But despite the wave of product recalls in recent months, many sourcing specialists maintain that most manufacturers in China are sophisticated enterprises, with years of experience serving Western needs. "Since China joined the World Trade Organization in 2001, they really do get it — 'it' being the need for product quality and safety," says Alan Schoem, senior vice president in the global product risk practice at insurance broker Marsh, and formerly the head of the compliance office at the CPSC.

Others concur. "Thousands of American companies import millions of different products every year from China that are of the highest quality and safety," says Gene Rider, vice president of global retail services for Intertek Plc, which assists companies by monitoring foreign-supplier quality and safety. Asked to explain the high rate of product recalls, Rider notes that not all the recalls were for manufacturing defects. "On average, two-thirds of the recalls were the result of design defects," he says, "and you can't blame China for that."

Rather than trim their sourcing from China, many companies expect to increase it. "Forty to 50 percent of our sourcing on behalf of our customers is from China, compared with 30 percent five years ago," says John Caltabiano, vice president of sourcing at Solectron Corp., an electronics manufacturing services provider. "We expect this to grow."

But Caltabiano acknowledges the concern over product quality. "The recent quality lapses of products made in China are alarming and should be of great concern," he says. "However, the electronics industry is well established in China, and the components being manufactured in China are not life-threatening issues."

Genlyte has no plans to reduce its dependence on the 20-plus factories in China it sources from. "We've been manufacturing in China for 20 years, and many of our suppliers have been with us over that duration," says Ferko. "To ensure quality, we have a small staff of indigenous contract employees in China that works exclusively for us. We've trained them to identify quality issues and to maintain our standards, working closely with suppliers to ensure they understand our definition of quality and confirm that the products meet our specifications."

Read the full article here.

Russ Banham is a contributing editor of CFO

© CFO Publishing Corporation 2007. All rights reserved.