Is It the Economy, Stupid?

We get letters department: Here at Stereophile, we talk to people in the high-end audio industry all the time, and we frequently get fascinating emails from movers and shakers within the industry. This week we received one that got us thinking about outsourcing manufacturing and how it could affect high-end consumers.

David Smith, a speaker designer who has put in time designing for JBL, KEF, Meridian, McIntosh, Snell, a/d/s, Infinity, and, most recently, PSB, wrote to tell us that he'd left PSB at the end of 2007. Perhaps it would be more accurate to say the job left him: Lenbrook-owned PSB had moved its manufacturing to China and reorganized its engineering staff, moving some positions to its Chinese vendors.

Fair enough, Smith says. He was well-treated and left with good feelings toward PSB, but he is concerned about the implications of moves like this. Smith has worked for many engineering-oriented companies in his career and he says this is the first time he's ever left one and not found any similar companies looking for design talent. "As Chinese manufacturing became competitive," Smith wrote, ". . . it was natural to move there. . . . What's really interesting is that companies are just as quickly divesting of their engineering. There has always been a notion that manufacturing can be outsourced to the most efficient factory and a good brand only needs marketing and product development. The problem is that it is hard to separate product development from manufacturing. . . . Manufacturing capabilities determine how a product is designed, determine how it should be built.

"The fly in the ointment is that there is, as of yet, very little design talent in China. I'm not saying that the Chinese can't learn audio engineering . . . but it takes time. So, in the short term, we have an odd situation where companies have divested of their engineering (all or in part) [and] the Chinese can't take up the slack."

I called Smith and we continued the conversation. "What this means for people like me," Smith said, "is that we move to China and work for a Chinese factory or become a sourcing intermediary or a consultant based in one of the special economic zones, where the factory cities are."

Moving the engineering to the factories has implications for the consumer, Smith feels. As the factories have greater control over the products they make, innovation may well be the first casualty. Smith pointed to Quad's move to Shenzhen as an example. The products are made extremely well, he said, but the company's biggest successes have been the updated Quad II amplifier and the UK-designed ESL-989. "It's just not Peter Walker's company any more," Smith said.

Smith isn't all doom and gloom, however. "There are some great tubed components coming out of China," he said. "Virtually all of the curvy cabinets that are popular in current loudspeakers are due to highly-motivated Chinese cabinet shops."

I spoke to Gordon Simmonds, Lenbrook, Inc.'s CEO, and he confirmed that the field of production engineering has indeed changed, but he's not convinced that out-sourcing manufacturing overseas is the sole culprit. "Our company [Lenbrook owns NAD, as well as PSB] has never owned its manufacturing facilities, so some form of on-site presence has always been part of the situation," he said. "But design has changed radically in the last decade—prototypes are increasingly designed using computer-assisted design (CAD), so the whole 'let's build cabinets until we make one that works' process is no longer necessary. Paul Barton might mock up a cabinet of a certain capacity and put drivers in it, but a lot of the final details are accomplished in CAD."

Simmonds agreed with Smith about the high-quality of Chinese cabinetry. "It's not so much that we couldn't have complicated cabinets made in North America," he said. "However, in addition to the cost, there's a faster turn-around from Chinese factories."

I don't know if you caught it a few paragraphs up, but Smith mentioned working for "a sourcing intermediary," which is one of those job functions that only exists in places like modern China, where factories are proliferating on a daily basis, roads are built by private contractors, and knowing who makes what where and how to get things from point A to point B becomes a valuable commodity.

In his fascinating blogs from China, where he now lives, James Fallows has written extensively about sourcing intermediaries, especially Liam Casey, a man Fallows dubbed "Mr. China." You might describe Casey as a "fixer," the man who hangs out in Shenzhen's Four Seasons hotel and connects visiting designers and entrepreneurs to factories, but that would ignore the chaos that is modern China. Casey has a comprehensive database of manufacturing facilities he has harvested from visiting them and then logging their GPS coordinates from his cell phones. He knows which roads are open (China's roads are constantly changing—new ones open, old ones close because of lax infrastructure maintenance, and the official maps are hopelessly out of date) and he knows where suppliers are located, and thus, how to get the bits and bobs that go into components to the manufacturers.

Logistics such as this—and the fierce competition to eke every quarter of a cent's profit out of a product—all too frequently lead to what some China-hands refer to as "component creep": the unauthorized substitution of a specced component by one "just the same," but cheaper. That's why many companies that have moved their manufacturing to factory cities maintain two or three non-local engineers on site.

That's a bit puzzling, since many of those facilities are ISO 9001-certified, which means, among other standards, every product manufactured must be compared to a reference prototype and measure identically. Smith snorted at that: "Yes, and all of those toy factories that produced toys coated in lead paint are RoHS-certified, which means there isn't supposed to be any lead near the factory . . . and if you add up all of the license fees on those $79 DVD players at Wal-Mart, that'd total over $100. Let's just say that it's not just the factories that are showing selective vision in this matter."

In his March column for Locus, writer Cory Doctorow kind of sort of addressed a point that may also have implications for high-end audio manufacturing in China: China may be running out of cheap labor.

Doctorow's example used Amazon's Kindle and Nintendo's Wii for fodder. The Kindle is Amazon's electronic reader (hilariously parodied here), while the Wii is Nintendo's $529 game console. Guess which one sells 17 per second?

The two don't even remotely compete in the marketplace, but they do compete for manufacturing capacity in China. Doctorow points out that while 160 million people moved from farms to the factory cities, even that supply of man-power is not unlimited. Niche products—such as electronic readers or high-end audio components—are competing with games, cell phones, sneakers, toys, and thousands of other popular products for line capacity and human resources.

Doctorow concludes: "Hackers are a commodity. Devices are a commodity. High-quality factories are not."

I was discussing this very point with VAS Audio's Sze Leung, importer of Cayin components, yesterday. He pointed out that there are dedicated audio manufacturers in China (Cayin, for example), but on top of the infrastructure demands and the increasing cost, even in China, of skilled labor, his business was running foul of the plunging US dollar. "We buy parts from Canada, from Germany, from Japan—and all of them are getting more expensive as the dollar loses value. We're going to have to raise prices in April—and we still won't be where we were when I first started bringing Cayin into the US."

What's going to happen? Leung thinks China may soon be thought of the way Japan was in the 1980s and '90s: the jewel of Southeast Asian manufacturing. He thinks Vietnam and, inevitably, North Korea will supply the next waves of cheap labor. Jokingly, he suggested that, by then, China and India will be outsourcing their customer service call-centers to the US for economic reasons.

Ha bloody ha.

Ironic postscript: Between the time I wrote the above and we completed fact-checking, both BMW and Sennheiser have announced that they are moving more production to the US as a cost-cutting move—and a hedge against the falling dollar's lack of buying power in the EU. Volker Bartels, Sennheiser's president of manufacturing and logistics, told NPR there was an additional reason for moving production to Albuquerque, New Mexico: moving manufacturing facilities closer to the company's US customers results in faster delivery times.

Is it possible the dollar's plunge will revive the rust belt? Like it or not, we're gong to find out.