Foreign companies lured by more than just cheap labor

For more than two decades, cheap labor has been the main attraction for U.S. firms looking to invest in China. Now there are more factors at play that have encouraged these companies to stay.

Thousands of skilled technicians are busy working on assembly lines at a Caterpillar factory in the city of Xuzhou in east China's Jiangsu province.

Located in the Xuzhou Economic and Technological Development Zone, the factory is able to receive almost all of the parts it needs from local suppliers, with local logistics firms helping to move the factory's products anywhere in the country within days.

With a new workshop under construction and more expansion plans underway, the factory is expected to grow into Caterpillar's biggest excavator production center in Asia by 2014.

"Although costs have increased, we will continue to make significant investments in China," said Doug Oberhelman, chairman and CEO of Caterpillar, a leading U.S. construction equipment maker.

Persistently high inflation has encouraged the government to raise the minimum wage in recent years, a move that has also increased operational costs for some companies.

"Rising labor costs are just one more thing that we have to overcome, but all and all, I'm happy with the returns for our Chinese business, as we have a business model that serves us well here," Oberhelman said.

"The market in China for our business is big and we have a lot of room to grow. So I intend to invest in a large way inside China," he said.

Entering China in the 1970s, Caterpillar currently has 17 production facilities, four R&D centers and three logistics and parts centers in the vast country. China has become the company's second most important market after the U.S. market.

In the last quarter of 2011, one-fourth of Caterpillar's Asia Pacific sales came from the Chinese market.

Coach, a U.S. leather goods company, recently stated that it plans to open 30 new stores annually in China over the next three years, aiming to expand its market share to 10% by 2014 from 6% in 2011.

Victor Luis, president of Coach International Retail, said the company expects China's accessories market to expand to 20% of the global total by 2016, up from 10% in 2011.

Despite increasing labor costs, U.S. multinationals have tended to expand their investment in China, as many of them still have just a small share of the country's massive consumer market.

According to a report released by the American Chamber of Commerce in Shanghai, two-thirds of surveyed U.S. companies reported that their China revenue growth has been higher than that generated worldwide.

About 72% of the companies surveyed increased their investment in China last year, while 77% plan to boost investment in 2012, showing their confidence in China's growth.

China's GDP growth, which slowed to nearly a three-year low of 8.1% in the first quarter of the year, is widely expected to pick up in subsequent quarters.

"The principal advantage that China has is its huge domestic market," said John Quelch, dean and vice president of the China Europe International Business School.

Higher labor costs may turn away low-end manufacturers, but U.S. firms will find it more convenient and cost-effective to do their manufacturing in China, Quelch said.

Compared with some Asian countries, China still excels in terms of its overall industrial operating capacity, labor scale, skill level and logistics, said Manoj Vohra, an Asia analyst at the Economist Intelligence Unit.

Labor costs are low in some countries, but logistics performance and annual productivity growth are less satisfactory in those countries than in China, he said.

Meanwhile, higher wages will mean greater purchasing ability, which will enable people to consume more, Vohra said.

Many foreign companies choose to stay in China, as they expect the economy to overtake Japan to become the world's second-biggest consumer market by 2015, he added.

Luo Jun, chief executive officer of the Asian Manufacturing Association, previously said that although labor costs have risen significantly in China in recent years, they remain around one-tenth of the average level in the United States.

Enterprises should not passively wait for new low-cost markets to emerge, Vohra said, adding that they should move upwards on the industrial chain by boosting productivity and innovating.

Data showed that foreign direct investment (FDI) dropped 2.8% year-on-year in the first quarter of the year, although FDI from the United States climbed 10.1% during the period.