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HR: Uncover the Hidden Costs of Human Capital in Tier 2 and Tier 3 Cities
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altWith the 12th Fortune Global Forum just being held in Chengdu, a typical second tier city in western China, more and more emphasis has been put on the further development of Tier 2 cities in China. Running factories in cities like Beijing, Shanghai and Guangzhou is considered to be quite costly. With the aim of lowering the cost, an increasing number of businesses are starting to think about building factories in Tier 2 and Tier 3 cities in China where the cost of labour, resources and land is much lower compared to the expenditure in first tier cities. According to RMG’s China Talent Flow Survey report, the salary level in Tier 2 and 3 cities is about 70% to 80% of that in Tier 1 cities. Furthermore, due to the fact that developing businesses in Tier 2 and 3 cities actually quite fit the strategy of the Chinese ‘go-west’ campaign, a lot of companies firmly believe that transferring to Tier 2 and Tier 3 cities can lower the cost, especially in the case of manufacturing businesses. However, there lies the uncovered cost in managing human resource capital while calculating all the expenditure. Therefore, I would suggest that those who plan to pan their treasure in the goldfield should think twice before acting.

Firstly, let’s talk about the production rate in the smaller cities. Developing a good workforce in the new land does not necessarily bring companies benefits in terms of the production rate. To be specific, looking for factory workers and preparing them to get ready to work is a difficult process with the costs of both time and money being high. Moreover a newly trained workforce is less efficient and proficient in comparison to skilled workforces from Tier 1 cities in terms of industry development, educational background and employee training levels. In general, compared to the ratio of skilled workers in first tier cities, the production rate in undeveloped and developing cities just reaches 60% to 80%.  The process of the production has profound effects on subsequent processes, which finally leads us to the product percentage of pass. Taking quality control into consideration, the passing rate in non-first-tier cities only reaches 85%.

altLet me illustrate this case with an example from a factory in Chengdu, where renting and operating costs account for only 30% of that in Beijing and Shanghai. Assuming that there are 1,000 workers in a factory, the average monthly salary of those who work in Tier 1 city is about CNY 4000. The annual output value of the factory is CNY 80 million, and the expenditure of renting and operation is about 1/4 of the annual output value. Moving to Tier 2 and 3 cities can help the factory save CNY 26 million, which includes a CNY 12 million salary (4000*1000*12*25%) and CNY 14 million renting and operation costs. As mentioned above, however, the product rate will be decreased to 75%, which means that the profit margin will drop to CNY 51 million (8000mln*75%*85%). In this regard, the annual output value actually is decreased by CNY 29 million which is CNY 3 million more than the saving; let alone the cost of training and recruiting. It can be seen in this presumption: when it is the moment for companies to generate return on investment, the efficiency and proficiency of those newly trained workers will probably disappoint a lot of companies. 

Another issue to be concerned with is the process of “brain gain” at the management level. To find the right management leader and move him or her to the sub-company in Tier 2 or Tier 3 cities creates issues.  So, we have to deal with such factors as relocation. Instead of regarding it as a minor issue, companies need to take several factors into consideration. Asking management personnel who have lived and worked in a big city for years to relocate to a smaller city is absolutely a difficult task. Should an apartment be prepared, should the family members move together, should the company gives to the family, and should the salary level remain the same, etc. are all details that companies must consider.

altIn general, the “brain gain” process can be achieved either by hunting  for talents from other companies or by looking around within the company. In both ways, companies need to benefit the chosen one by offering housing subsidies, salary increases, round trip tickets, or a one-time family allowance. Actually, as for the housing subsidies, in order to ensure fairness inside the company, more and more companies tend to choose salary increases. Sometimes companies will offer an extra contract signing bonus for talents hunted from other companies. With these choices, the only problem left for the company is to balance them in order to get the best one for both sides. Though companies think they might make the right decision, problems might still appear sooner or later. For instance, one of the typical problems is whether the management personnel are able to get used to the new working and living environment as soon as possible. And what if he or she does not move on well?

The last issue to be considered is whether companies are ready to bear the risk of a “brain drain”. Asking high level employees to relocate in another city brings concerns, especially with regard to one’s career development. Relocation not only means that the talent will work and live in a new city, but it suggests that one should develop their new social network for work as well.  Developing new relationships takes more than a day or two. It is a long-term project. When considering moving to another city, these people will have to decide whether they would like to restart everything. In another sense, whether or not companies have planned the career development path for these employees also matters in this regard. If the relocation process pushes management personnel to a dead end on their career path, the company needs to be careful with the issue of a “brain drain” occurring.

However, you might say that there are a lot of companies that moved to Tier 2 and Tier 3 cities which have embraced great success and benefits. Of course, the ideas here are only suggestions for companies who have a plan of action. Every company encounters different troubles and solves these problems quite differently,  so this is time for the wise to utilise their wisdom. 
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