If you’re sourcing or manufacturing products from China you will have started having conversations with your factory around pricing - specifically, that your product prices are rising anywhere between 10% - 20%.
This might not sound surprising to most people as price changes are expected due to the impact of COVID-19. However, normal pricing conversations are in the realms of 2%-5%, so why have prices increased so dramatically in China in 2021?
To put this challenge into context, In the last 10 years, we haven’t had such drastic price changes across the whole industry. The last major pricing challenge faced by manufacturers was in early 2011 and even then, this was resolved in the course of 4-6 months. Our current price increase is projected to stay with us throughout 2021.
For greater context, typically 10%- 20% would be a factory’s profit margin, so when a factory is requesting 10-20% increases, that means costs have increased to the point that they are not profitable. Normally 2-3% a factory can absorb with little problem, to keep a really good working relationship with their customers; factories would accept lower margins rather than risking the customer going to a competitor.
So 10%-20% really means factories are in a tough spot and have no other choice but to increase the price: else they run the risk of going out of business. In this blog, we will be exploring the major factors that are contributing to the price increases and why we think the price increase is here to stay with us in 2021.
I’m a customer. Why do price increases in China affect me?
Many companies along the supply chain rely on a margin between 10 - 20%, so following the factory’s suite. If the supplier/ reseller/retailer is not making any money, then they will have to pass the costs up the chain to the next person who will, in turn, pass it to the next person in the supply chain; eventually, this additional cost ends up at you the customer.
The main differences between 2021 and 2011 are that the price increases stem from labour shortages, vastly fluctuating supply/demand due to COVID and across the board prices change dramatically on a daily basis; this is all the way from raw materials, electronic components and freight costs.
The main factors we see affecting the price increases in China are:
Base raw material costs have increased by 10% - 30% in China compared to 365 days ago:
Silicon -5-5-3 increased by 13.8%
Copper increased by 42.53% - reaching an all-time high of $10,724 USD per tonne
Iron Ore fine - 65% EXW Laiwu increased by 34.93%
Crude Oil WTI (USD/Bbl) - increased from$24 to $65 USD
Many industries within China are speculating on price increases and therefore stock pilling ICs, passive components and many base materials
US stimulus cheques coupled with a 2-3% inflation within the US are having an adverse effect on the USD / RMB exchange rate
The exchange rate is now $1 = 6.55 RMB rather than $1 = 7 RMB; most suppliers deal in USD so it's now more expensive to buy local materials and pay for labour.
With lockdowns easing globally, demanding is spiking across the supply chain and factories are unable to keep up with demand
Major electronics brands are cancelling orders but preventing factories from re-allocating their raw material to other customers.
Raw data can be in the sources section of this blog. The prices are changing on a daily basis and during the time of writing the blog, copper had hit an all-time high three times.
I am conscious that we are painting broad strokes to simplify the problem. The exact issues are going to vary vastly depending on the product, industry and even supplier base. Some will be in a better position than others. For an additional perspective let’s dissect a power cable to break down the components of a PCBA and their respective price increases. Electronic components ICs and PCBAs have increased by 20% - 50%.
From the image, it's easy to understand why suppliers are being caught out - the price changes are not affecting one element or one component of the board - rather the base raw material costs have increased, therefore a knock-on effect is that PCBA components have increased in price.
Base Raw Material Cost Changes
Raw materials are the building blocks of any product and are at the very start of the supply chain. All products have hundreds of separate processes that create the end product you purchase locally.
Before processing a product, if your base cost increases, your overall component cost would increase, see image. . If one or two parts of your 50 piece product go up, it isn’t a big problem. The product would increase by 1% or 2%. For the whole product to increase by 10%-20% a wide range of raw materials have to increase in cost simultaneously, forcing all suppliers to raise their prices.
Raw materials examples are Copper, Silicon, Iron, etc but less obvious examples in this category is Cost of Oil and agricultural goods; machines need fuel to work and people need food to work. If any of these prices increase, it affects labour and factory costs. In this context, Oil and Agricultural goods have also increased in price.
But Why 10% to 20% increase and why not 2% to 5%?
China’s Producer Price Index and US’s Consumer Price Index
With the cost of oil, copper and agricultural goods, it is somewhat obvious that prices would go up but it doesn’t dig deep enough into why there are such fluctuations. Usually, suppliers are very good at mitigating price fluctuations by forecasting, purchasing critical components in advance and having secondary/tertiary suppliers who also stockpile certain key goods such as raw copper.
It comes down to what many people don’t want to admit - China’s Producer Price Index (PPI) is closely tied to the US’s Consumer Price Index (CPI); this is because many trades and exports are purchased in US dollars (USD) and then converted to Hong Kong Dollar (HKD) or China Renminbi (RMB). It means that any inflation caused in the US heavily affects the purchasing power of Chinese factories when they purchase domestic raw materials. So anytime there are “Stimulus” cheques granted in the US, it is effectively driving the price of goods up in China.
Image source accredited to Bloomberg and US National Bureau of Statistics
Stimulus cheques is a cheque sent to a taxpayer by the U.S government. They are intended to stimulate the economy by providing consumers with some spending money. The boost of consumption of goods is to drive revenue of retailers and manufacturers, spurring on the economy. The effectiveness of it is a huge area of debate - one of which we will not get into in this blog.
It is not the first time stimulus cheques have been used - previously it was granted during the 2008 financial crash. During COVID-19, three rounds of cheques have been issued - March 2020 a rebate of $1200 per adult, December 2020 a rebate of $600 and then in March 2021 a direct stimulus payment of $1400.
The additional income is great for those who need it but forces inflation higher in the US, resulting in a weaker currency. If a currency weakens, it is worthless therefore you need more when purchasing goods. I.e $1000 one year later might only be able to buy $997 worth of goods the following year.
Image source accredited to US Bureau of Labor Statistics and BBC News
But still why 10%- 20%?
We still haven’t dug deep enough into this - typically markets can deal with and would result in a 5%-10% increase in price. Several more factors are compounding these problems. One solution to the stimulus checks is for factories and suppliers to absorb some of the costs.
Buy materials when they are cheap and sell them when they are in peak demand
Many companies within resilient supply chains will stockpile critical parts and components - our number 1 advice to companies in 2020 has been to have a stock of critical and long lead time components to ensure production can continue.
Taking this a step further there is an entire industry that focuses on purchasing critical components when they are cheap then speculating that the price will increase. Thereby hoarding stock until the price has gone up by a significant percentage which can be anywhere between 20% to 100%. Imagine a stock market but for electronic components.
During turbulent times where prices are already going up, businesses who rely on this model double up on their stock and effectively add wood onto the already large fire; increasing the price further. They would then advise other companies to do the same - it’s a sudo word of mouth bubble being created, adding to the problem.
If you’re a company that can’t procure stock, you will have to bite the bullet and purchase parts at a higher price, to ensure you can sell products - ultimately businesses can fail if there are no products to sell for an elongated period of time.
Normally bubbles pop and these “Fads” die down relatively fast, a period of 2 - 6 months. However, on this occasion, the price of all goods have been steadily increasing throughout 2020 and well into 2021.
To insult to injury - we still have yet another factor tieing up the supply chain…
Major Electronic brands cancel their orders but factories can not release stock
Early on in the pandemic - many large electronics brands such as Apple, Microsoft, Samsung and Lenovo cancelled many of their production orders; in theory, this is great for the supply chain because it releases previously tied up raw material that can be used in other products - Silicon being the most common factor here and used in every consumer electronic product.
In reality - factories are contractually tied to keep the stock for 6 - 18 months “just encase” Apple / Microsoft want to change their minds or keep the stock in the hope that the order is reordered so production can resume. For many companies, it is much easier to have one incredibly huge customer to produce for rather than dozens of smaller companies requesting very different product ranges.
Suddenly major factories had a huge stockpile of components and raw material but with no customers to produce for and unable to do anything with the raw material due to their contracts with Apple / Microsoft.
In a good year, you would have one, maybe two problems like we’ve talked about in this blog. During 2020 and 2021 - every month there was a new problem to solve with the supply chain which would compound onto the existing stack of issues.
Another separate problem worth noting are the effects of the Electronic Vehicle surge in China - re-shaping the supply chain for power banks, laptop batteries and any products utilising Lithium-Ion cells; we will park this newly emerged problem for another blog.
To recap the main points discussed in this blog
Raw material price increases
+ US stimulus cheques
+ US / China inflation
+ Global inflation
+ Tertiary suppliers opportunistically purchasing stock
+ Mass price speculation
+ Largest consumer electronics suppliers contractually obliged to keep stock + Low USD to HKD exchange rate
+ COVID-19 easing globally
+ Labour shortages
= 10% to 20% increase in costs.
A note on Shipping Containers
From Q4 2020 shipping containers have also increased in price by almost double; a 20FT container has increased from $2500 to $4800USD which has a significant impact on low-value goods such as packaging materials.
The increase in price is due to shortages of containers at major ports in APEC from labour shortages in the UK, EU and US. Labour shortages result in vessels being processed slower, thereby having a knock-on effect on ships scheduled to arrive shortly after. One week delays turn to two-week delays which quickly turns into 4 - 6 week delays where ships are anchored offshore, waiting for ports to clear up. To save on time, vessels are not re-loaded with empty containers, to take to the next port and balance out the uneven import/export from country to country.
According to official government figures from GOV.co.uk, taking the UK as an example, the UK imports £540 billion of goods and its top trading partners are Germany, United States, China, Netherlands and France. However, the UK exports £365 billion of goods with the same trading partner countries; 87% of these goods began or ended at a shipping dock. Therefore there is roughly £175 billion worth of empty containers that need to be exported to balance out the difference between what the UK imports and exports; this is applicable to many countries who typically import more than they export.
In short, without an empty container returning to China, containers would stay in the UK, EU or US clogging up warehouses and storage places. With vessels arriving late at major ports such as Felixstowe or LAX then leaving the port without re-fill on new (empty) containers - many ports in the US and UK have a surplus of containers. China has a shortage of containers, resulting in prices of containers increasing due to supply and demand issues.
A common myth we’ve come across is the container cost increase being blamed on the increase of PPE being imported by countries. In some regards it is true but not to the extent where prices would double.
Final Thoughts:
2021 is an unusual year as many worse-case scenarios were presented to an already stressed supply chain. Fluctuating prices on raw materials, labour shortages, speculation and stock being tied are boosting the price of almost all consumer goods manufactured in China. As there is not a single reason why prices have gone up - price increases are here to stay in 2021 until they are resolved. In regards to cancelled order and inflation - this is going to keep a steady price increase as these take several years to resolve. For a business that needs stock, price is going to be an unavoidable issue and the general trend is going to be many consumer goods going up in price.
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