PACIFIC REPORT : The Allure of South Seas : Manufacturing: Indonesia and Malaysia are attracting substantial capital from the United States and other countries because of cheaper labor.

Bobby Grahm is willing to go to great lengths to get an edge on his competition. However, when Grahm in 1985 decided to go all the way to Indonesia--venturing into wild, mountainous regions devoid of telephones and paved roads to set up manufacturing facilities--some friends believed that he may have gone too far.

After all, manufacturers in Taiwan were already providing Grahm’s Los Angeles-based import business with a steady supply of hand tools, portable lamps and kitchenware. The doubters conceded that Indonesia’s low labor costs were attractive, but they were concerned that a commercial venture into undeveloped areas of that country would be financially and physically risky. They affectionately chided Grahm by dubbing him the “Indiana Jones of importers.”

Although some of his competitors have been forced into bankruptcy during the recession, Grahm’s business last year was buoyed by savings from his lower-cost operations in Indonesia and neighboring Malaysia--countries that are beginning to attract substantial investment from cost-conscious manufacturers from the United States and other countries.

Capital spending by U.S. investors in Indonesia and Malaysia has risen sharply since 1988. Many analysts believe that investment dollars will continue to flow to the two developing nations as U.S. firms emerge from the recession with a new sense of urgency about cutting costs.

U.S. manufacturers are late entrants to the investment party in Indonesia and Malaysia. Investors from Japan, Hong Kong, South Korea, Taiwan and Singapore--taking advantage of lower-cost labor--have moved more swiftly into those nations. Japanese industrial giants such as Sony, Matsushita, Mitsubishi, Hitachi and Toshiba have made Malaysia a manufacturing center for consumer electronics. Asian investors can also fuel their plants with low-cost oil from drilling sites in Malaysia and Indonesia.

In addition, outside investors will have first crack at rapidly growing consumer markets in the two nations. With more than 180 million people, Indonesia is the world’s fifth-most-populous nation.

Investments in Malaysia and Indonesia are not risk-free. Their governments are not as stable as those in Singapore and Japan. They have greater infrastructure needs--roads and telecommunications, for example--than some of their Asian counterparts. In addition, their economies have been sandbagged by bureaucracy, regulation and official corruption--problems that the governments have tried to resolve in recent years.

However, with great natural resources, burgeoning export potential, expanding consumerism and cheaper labor, Malaysia and Indonesia are poised to become the new magnets of foreign investment in the Pacific Rim.

Their governments have set out the welcome mat to U.S. investors. Feeling the bite of the recession and recognizing the need to expand their markets and supplier networks, more U.S. producers of low-cost goods--companies such as Grahm’s--will take advantage of the invitation, said Mike Van Horn, president of Pacific Rim Consortium. The consulting firm, based in San Rafael, Calif., advises companies on investment opportunities in Asia.

“Recessions sometimes prompt companies to switch their (supplier) sourcing,” Van Horn said. “Companies may not actually make such moves during the recession because they can’t afford the cost, but they’ll move later.”

Van Horn said U.S. firms began to invest more heavily in Indonesia and Malaysia in the mid- to late 1980s because labor costs in some other Asian countries had risen too high.

“As each one of these (Asian) countries upgrade and modernize their factories,” Van Horn said, “they begin to pay higher wages, driving out lower-wage industries. Taiwan is a prime example. It’s not just American companies leaving Taiwan because of rising wages. Taiwanese companies are also leaving Taiwan and moving to places like Malaysia and Indonesia.

“As each country moves up the ladder of economic development, they begin to send their investment to a less developed country,” he added.

If smaller companies begin to surge into these emerging countries, they will be emulating some of the nation’s largest firms. A recent study of 20 large U.S. manufacturers by A. T. Kearney, a Chicago-based management consultant, shows them reducing their cost of materials by as much as 30% during the past three years. Management typically tries to reduce operational costs, but in today’s recessionary environment, it is also smart to look at the cost of materials provided by suppliers, Kearney said in a report.

Materials--a much larger cost than operations--typically represent 60% to 80% of the total cost of goods at most U.S. manufacturing companies, the Kearney report said.

“Global sourcing approaches, in which companies literally view the world as their supply base,” are becoming a more popular method of reducing supplier costs, the report said.

Other management consultants concur--among them, corporate strategists at Standard Chartered Bank, a British trade finance bank with offices worldwide.

“It becomes more important in a slower (domestic) economy to find . . . export markets and to look for new suppliers,” said Terry Dowrick, a senior vice president at Standard Chartered in Los Angeles. “As companies look for new suppliers, they are turning away from Taiwan, Hong Kong and Singapore in favor of Thailand, Malaysia and Indonesia.”

Standard Chartered has helped companies identify investment opportunities and suppliers in Indonesia and Malaysia, guiding their clients through the nuances and intricacies of doing business there. The firm helped Grahm cope with stumbling blocks during a formative period of his Indonesian enterprise.

Grahm’s company, Associated Sales, established manufacturing operations in Indonesia and Malaysia in the mid-1980s to produce for export to the United States and other markets.

Together, factories in Indonesia and Malaysia now generate about 12% of Associated Sales’ goods. The company phased out its production facilities in the United States in the late 1960s because it could manufacture its Cobra-brand hand tools, portable lamps and kitchenware for 20% to 50% less in Asian countries, Grahm said. Labor in the United States today would cost Associated Sales 25% more than in Indonesia and Malaysia.

Significantly, the company is paying its Indonesian and Malaysian workers 10% to 15% less than what it pays its workers in Taiwan, another venue for Associated Sales’ production.

In fact, Associated’s history reads like a business odyssey of corporate America’s trek in quest of cheaper labor markets in the Pacific Rim.

Grahm’s father, Alan Grahm, was president of the firm when it established its first Asian presence, a 1954 deal in Japan. As Japanese production costs rose, Associated developed ties with suppliers in Taiwan and South Korea in the late 1960s, reducing its reliance on Japan.

With labor costs rising in Taiwan, Korea and Hong Kong, Associated in 1974 began to import from China. Today 40% of its goods are produced in Hong Kong and China. Sri Lanka supplies 10%, Thailand 3%, Taiwan 25% and suppliers in other nations 10%. Besides Indonesia, Associated has joint ventures in Taiwan and Hong Kong, and supplier deals elsewhere.

The low-cost operations in Indonesia and Malaysia became especially valuable when the recession took hold last year, Grahm said. Sales of hand tools in the United States dropped in 1990, prompting retailers and wholesalers to reduce the size of orders and seek cheaper supplies. Many commercial buyers and some of Grahm’s competitors failed to adjust in time.

“If you’re not flexible enough to change with the times, you can always go under,” Grahm said.

The value of the company’s sales contracts with U.S. retailers and wholesalers--normally in the $25-million range--did not dip appreciably last year, Grahm said. However, many of its bankrupt and failing commercial customers were unable to pay Associated Sales for their orders.

“Our earnings were down 50% in 1990,” Grahm said. “If we had not made adjustments by establishing new sourcing (in Indonesia and Malaysia), we’d be in serious trouble; we wouldn’t have had a profit. The cheaper sourcing enabled us to survive 1990.”

Grahm’s Indonesian operation is a joint venture that produces drinking glasses and some hand tools. Associated Sales invested $300,000 in equipment for the Indonesian operation in 1985. It has imported glassware from Malaysia on a contract basis since 1986.

Like owners of many other U.S. firms in those nations, Grahm sometimes had to yield to frustrating government regulation and protectionism. For example, he said, the Indonesian government placed a prohibitively high duty on plastic bubble wrap commonly used in packaging, forcing him to use locally produced packaging paper.

Like some more cost-conscious U.S. investors, Grahm chose to set up operations in a more remote part of Indonesia to reduce labor costs. His products are manufactured at a plant 40 miles from the town of Semerang--far away from the island nation’s modern capital of Jakarta, a metropolis of more than 7 million.

Grahm recalled his first visit to that region: “I had to take a plane and then a truck to the middle of the jungle, an area that had no telephones. They used wireless transmitters like ham radios to communicate with cities. It was tropical and hot and humid, and there were only dirt roads. In the middle of all this was a huge factory with smokestacks.”

The owner of the plant and Grahm negotiated a deal: Grahm agreed to ship in the necessary equipment, and his business partner provided the labor--about 100 workers.

“When I went to Indonesia, I had a weird, leery feeling,” Grahm recalled. “But when I saw what they could do after visiting the factory, I realized that the facilities and the workers were very capable. . . . I felt good about it. Looking at the terrain, I told myself, ‘The competition will never come here.’ ”

However, since that initial visit, many foreigners have established supply lines in Indonesia. Further economic development--and the attendant rise in labor costs--are coming to that nation. Meanwhile, Grahm--thinking about his next move--is beginning to consider the potentially low-cost labor markets of very different investment-hungry countries.

“I’ve wondered how to stay one step ahead,” he said. “Perhaps we’ll go to the Soviet Union . . . or Vietnam.”

THE MALAYSIA-INDONESIA ADVANTAGE

Sales generated by manufacturing operations of U.S. subsidiaries in millions of U.S. dollars.

1983 1984 1985 1986 1987 1988* Malaysia $1,716 $2,130 $1,930 $1,982 $2,512 $2,859 Indonesia 359 282 285 304 288 512 Hong Kong 1,049 1,315 1,227 1,217 1,676 1,907 Taiwan 1,658 2,043 1,935 2,075 2,576 3,498 South Korea 519 593 600 588 768 1,026 Singapore 2,375 3,202 3,073 3,102 3,966 4,847

Average annual compensation per employee at manufacturing operations of U.S. subsidiaries in U.S. dollars.

1983 1984 1985 1986 1987 1988* Malaysia $3,595 $4,146 $4,509 $4,382 $4,449 $4,971 Indonesia 4,043 3,947 5,161 5,789 6,596 6,727 Hong Kong 4,241 4,203 5,375 5,841 6,838 7,828 Taiwan 4,382 5,070 6,086 6,069 7,944 9,871 South Korea 4,722 5,287 5,940 6,165 6,484 8,108 Singapore 6,183 7,113 8,329 7,370 8,088 10,200

*includes some projections for that year

Source: U.S. Commerce Department, based on company surveys.